22 Oct 2010 | Capital Hill

Capital Hill on... Bank rates 

Your starter for ten: when did interest rates hit their historical low of 0.5%? You’d be forgiven for forgetting, because it was some time ago – 5 March 2009. Bank rate hit a recent peak of 5.75% on 5 July 2007, and gradually fell to 4.5% on 8 October 2008 before plummeting 4% in the space of five months.

Earlier this month, the Monetary Policy Committee (MPC) left rates unchanged for the 19th consecutive month amid fears over the sluggish economic recovery. Committee member Andrew Sentence has been the lone hawk since June, voting for a quarter-point rise to 0.75% on the grounds of above-target inflation. Policy makers raise interest rates when they want to moderate demand for goods and services, and therefore bring inflation to heel.

It has proved sticky throughout the entire financial crisis and, at 3.1% in September, is well above the Bank of England’s 2% target. 

However, the other eight members of the MPC are watchful of hampering the fragile economic recovery. Higher rates would put pressure on household budgets at a time when the coalition government’s austerity measures are already expected to bring about rises in unemployment and lower consumer confidence.  

Bank rate, which has had various names over the years, has now been unchanged for the longest period since the Second World War. It fell to 2% on 30 June 1932 – then the lowest it had been. As a result of the Great Depression, it remained at 2% until August 1939, just a few days before the outbreak of war, when it was increased to 4%.  

Today, Bank rate remains at its lowest ever, and most economists expect it to stay so for some time. Increases, when they do come, are expected to be gradual. So, what does all of this mean? Well, Bank rate determines lots of things, some of which are pretty clear. 

If you have a tracker mortgage, where the rate you pay is pegged to Bank rate, your monthly repayments will change in line with movements in interest rates. Movements in cash savings rates roughly mirror changes to Bank rate, too, and have fallen to the lowest Britain has ever seen: the average instant access savings rate is at a rock-bottom 0.77%, according to Moneyfacts, the data firm.  

The wider mortgage market, asset prices and exchange rates also have a relationship with Bank rate, though less obviously so.

The London Inter-Bank Offered Rate (Libor) is the rate at which international banks lend to each other, and sterling three-month Libor influences the level at which lenders set some rates on loans, especially mortgages, to consumers and businesses. It also impacts on the amount they will lend.

It’s largely a reflection of how much they trust each other. Three-month Libor is generally 10 or 20 basis points (i.e. 0.10% or 0.20%) higher than the Bank rate, but the credit crunch widened the differential hugely. The margin has since narrowed, but still stands at around 25 basis points, and is keeping rates on mortgage deals higher than they might otherwise be. Moreover, some new mortgage deals have been linked to Libor rather than Bank rate or a lender’s standard variable rate, as banks try to match their loan rates to their costs.  

Low interest rates can also lead to a weak pound, as investors try to find a better home for their cash than holding sterling on deposit. Low interest rates should also boost house and share prices as demand for these assets increases amid paltry savings rates.  

As we’ve seen, though, when times are tough everything can head in the same direction. And there are no points for guessing what that is.
 

Author: Jennifer Hill
Jennifer is an award-winning British financial journalist. She recently left The Sunday Times, where she was deputy Money editor, to set up her own company, Media Hill Ltd. She is a previous personal finance correspondent of Reuters, the global news service, and personal finance editor of The Scotsman newspaper.

She has won or been shortlisted for six Headlinemoney awards, the ‘Oscars’ of personal finance journalism in the UK. She has also scooped or been nominated for accolades from the Association of Investment Companies, Ignis Asset Management, the Association of British Insurers and the British Insurance Brokers’ Association.