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The Bank of England's base interest rate determines the interest rate that banks and other lenders charge on mortgages, loans, and savings accounts in the UK. This article provides a detailed overview of how the Bank of England savings interest rate works, current rates, how rates are set, factors that influence rate decisions, and the impact on savers.
What is the Bank of England Base Rate?
The Bank of England base rate, also known as the Bank Rate or Official Bank Rate, is the interest rate that the Bank of England charges banks and other financial institutions when they borrow money. This influences the rates those lenders charge consumers.
The base rate is set by the Bank of England's Monetary Policy Committee (MPC). The MPC meets 8 times a year to review economic conditions and set the rate accordingly. Their aim is to keep inflation at the government's 2% target level.
Raising the base rate helps reduce inflation while lowering it stimulates spending and borrowing. The current Bank of England base rate as of August 2023 is 1.75%.
How Does the Base Rate Affect Savings Accounts?
When the Bank of England raises the base rate, banks and building societies generally pass this on by increasing interest rates on their savings accounts.
So when the base rate goes up, you can expect to earn more interest on your savings. Equally, when the base rate falls, savings rates typically decrease too.
Banks don't have to exactly mirror adjustments in the base rate, but savings rates tend to follow the general trend. Exactly how much your interest rate changes depends on the individual bank or building society.
Types of Savings Accounts Impacted
The Bank of England base rate influences interest rates across all types of savings accounts, including:
- Easy access accounts
- Notice accounts
- Fixed-rate bonds
- Cash ISAs
- Children's savings accounts
So whether you have a rainy day easy access account or are locking money away in a fixed-rate bond, the underlying savings rates are affected by the Bank of England's moves.
Current Savings Rates
As of August 2023, the average easy-access savings account pays around 0.7% AER interest according to Moneyfacts. 1-year fixed rate bonds pay an average of 2.52% AER.
These are significant increases compared to 12 months ago when easy access accounts paid 0.28% AER and 1-year bonds just 0.83% AER on average.
Top-paying accounts offer over 2.5% interest on easy access deals and over 3.5% on 1-year fixes.
Bank of England Interest Rate Forecast
The Bank of England raised the base rate multiple times during 2022 and early 2023 as inflation surged. Further gradual rises are expected over 2023 and 2024.
Economists predict the base rate could reach around 2.5% by mid-2024. If these forecasts are accurate, savings rates will continue trending upward but not dramatically higher.
Of course, there are many uncertainties, including energy prices and the war in Ukraine. If the economy performs worse than expected, rates may not rise as high.
How the Bank of England Sets Savings Rates
The Bank of England's Monetary Policy Committee (MPC) sets the base rate. Their primary goal is keeping inflation at the 2% target.
If inflation looks set to exceed the target, the MPC will likely increase rates. This should help bring inflation down. Lower rates can stimulate inflation.
The MPC aims to balance multiple economic factors when setting rates, including:
- Inflation - The Consumer Prices Index is the main measure. Above-target inflation tends to lead to higher rates.
- Economic growth - GDP and output levels indicate economic health. Weaker growth can prompt rate cuts.
- Employment - The aim is to maintain high employment. Rising unemployment may lead to lower rates.
- Wage growth - Faster pay growth can indicate inflation pressures, driving rate hikes.
- Debt levels - High household debt may discourage large or fast rate rises.
- Currency exchange rates - A weaker pound can cause imported inflation.
- House prices - Booming property inflation may require restraining with higher rates.
Essentially rates are increased when the economy is growing strongly and lowered during downturns or times of uncertainty.
Factors That Influence the Bank of England's Decisions
As well as economic data like growth and unemployment, the MPC looks at global events, financial markets, political changes, and forecasts when setting rates.
Some key factors that can impact their decisions include:
- Inflation - Strong inflationary pressures make rate rises more likely. Weak inflation could lead to decreases.
- Economic growth - Recessions typically cause rate cuts to provide stimulus. Strong growth may prompt hikes.
- Employment - Low unemployment and fast job creation encourage rate rises. High unemployment causes decreases.
- Brexit - Ongoing Brexit impacts could influence rate decisions in either direction.
- Oil and commodity prices - Higher prices drive inflation and rate hikes. Falling prices cause decreases.
- Currency markets - A weak pound pushes up import costs, leading to hikes. A strong pound has the opposite effect.
- Debt levels - High household debt may limit rate increases. Low debt allows more flexibility.
- Housing market - Rapid house price growth could lead to restraining rate rises. Weakness may encourage cuts.
- Political changes - New governments and policies could force MPC to rethink monetary policy.
- Global economy - Downturns such as recessions require cuts. Strong worldwide growth enables hikes.
So a complex mix of UK and global factors are regularly assessed when setting the base rate.
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How Changes Impact Savers
For savers, the main impact of Bank of England rate changes is the effect on savings interest rates.
Higher rates are good news for savers. You'll earn more interest on your savings in bank accounts, giving higher returns. This can help savings grow faster.
But higher rates also mean mortgages, loans, and other borrowing becomes more expensive. Consumer spending may also be restrained.
Lower rates have the opposite effects. Interest earned on savings drops, giving lower returns. But borrowing becomes cheaper, providing a spending boost.
So there are positives and negatives depending on your personal financial situation. Retirees and others reliant on savings prefer higher rates and low inflation. Borrowers benefit more from low rates.
Pros of Higher Rates for Savers
The main advantages of higher Bank of England interest rates for savers are:
- Increased savings returns - You earn more interest in bank accounts and fixed bonds, allowing savings to grow faster.
- Fight inflation - Higher returns can offset high inflation erosion of savings in cash accounts.
- Savings incentive - More attractive interest gives a greater incentive to save money rather than spend.
- Retirement income - People depending on savings have more income in retirement.
- Deposit protection - Money in savings accounts is protected by FSCS up to £85,000. Higher returns provide security.
Rising rates improve returns across savings accounts. Easy access, fixed bonds, Cash ISAs, and children's accounts typically pay more as the base rate increases.
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Cons of Higher Rates for Savers
There are also some potential drawbacks of higher interest rates:
- Mortgage costs increase - If you currently have a mortgage, rate hikes raise repayment costs.
- Borrowing more expensive - Loans, credit cards, and overdrafts become pricier.
- Reduced consumer spending - Higher costs lead people to be more cautious about spending on non-essentials.
- Dampened economic growth - Rate rises slow the economy by restricting borrowing and expenditure.
- Stock market impacts - Higher rates can make shares less attractive, causing values to fall which reduces wealth.
- Lower annuity rates - Those seeking to buy annuities with pension pots get lower incomes.
- Bank closures - Persistent low rates have led banks to close loss-making branches. Higher rates may continue this trend.
So while overall positive for savers, higher interest rates do have some potential downsides to consider too.
Bank of England Savings Rate FAQs
How quickly do savings rates change after a base rate increase?
Banks and building societies usually alter savings rates within 1-2 months of an official change in the Bank of England base rate. Most providers link their savings and mortgage rates to the base rate.
Do all savings accounts increase when the base rate goes up?
The large majority of variable rate savings accounts will see a rise following a base rate hike. But not all savings rates are guaranteed to increase. Some providers are slower to react than others.
How much will my savings interest go up if the base rate rises by 0.5%?
As a rough guide, a 0.5% base rate rise typically pushes up savings rates by around 0.3% to 0.4% over time. But the increase depends on the individual bank or building society and specific account terms.
Are fixed rate savings immune to base rate changes?
No, fixed-rate savings accounts are not immune. The rates on new fixed bonds being offered after a base rate change will eventually reflect the move. Existing fixed-rate savers will keep the same rate until their term expires.
Does a higher base rate guarantee better savings rates?
Not always. Bank funding costs and competition also impact savings rates. So rates don't move in perfect lockstep with the Bank of England base rate. But over time, higher base rates translate to improved savings deals.
Will my Cash ISA rate increase if the base rate goes up?
Yes, most Cash ISA rates move up over time after a rise in the Bank of England base rate. Cash ISAs provide tax-free savings interest rather than higher rates. Make sure to use your annual ISA allowance.
Conclusion
The Bank of England base rate has a major influence on interest paid on UK savings accounts. Rising rates will generally see savings rates improve over time, while cuts cause declines. Keep an eye on base rate decisions and consider shifting savings when accounts don't keep pace.
