UK base rate explained - and how to respond to changes

Eight times a year, the Bank of England’s (BoE) Monetary Policy Committee (MPC) meets to decide the UK’s interest or base rate. When this happens mortgage and savings rates will feel the impact, affecting consumers across the board. Below we have explained what the BoE’s base rate means and how it affects you.

In essence, the base rate refers to the interest the BoE charges lenders for borrowing its money. As a result, this affects the interest rates banks and building societies charge on many of its products. In theory, if the base rate is lowered, so do the rates on mortgages and savings accounts and vice versa.

As explained in our inflation guide, base rate and inflation have a direct relationship. This means when inflation rises or falls, the base rate generally mimics this action.

This is because the BoE’s MPC uses interest rates to control inflation. If the cost of borrowing increases, then consumers are encouraged to save their money instead. When this happens, economic activity subsides and so does inflation.

Likewise, if interest rates drop, borrowing looks more attractive. This is usually done in periods of low inflation when the BoE encourages spending and economic growth. Businesses and consumers aim to take advantage of low rates and borrow more, which increases economic activity and therefore inflation.

The MPC, which comprises nine members, meets roughly every six weeks to determine whether the base rate should remain the same, increase or decrease. The MPC includes the following members

• The Governor of the Bank of England
• Deputy Governor for Monetary Policy
• Deputy Governor for Financial Stability
• Deputy Governor for Market and Banking
• The BoE’s Chief Economist
• Four external members appointed by the Chancellor

This committee is also joined by a representative from Her Majesty’s Treasury who cannot vote on the outcome. Instead, their role is to brief the committee on any policy issues and fiscal policy plans which might influence their vote.

The BoE plays a significant role in protecting the value of the pound and ensuring prices remain stable across the economy. To achieve this outcome, the base rate needs to change and can never stay constant.

Another way the BoE achieves this outcome is through the unconventional means of quantitative easing.

Ultimately, a low base rate makes borrowing cheaper. Therefore, in theory, a low base rate will benefit businesses looking to borrow money and upscale their assets. Consumers looking for a loan or mortgage will, in theory, have access to cheaper borrowing.

From the perspective of a saver, on the other hand, a low base rate is not ideal. This is because the lower the base rate, the cheaper it becomes to lend money which limits the returns a saver can earn on their funds. 

A low base rate can be positive or negative for the broader economy. Factors such as unemployment figures, value of the pound, and Government spending (or fiscal policy) can influence one’s opinion on the current base rate.

A rise in base rate will likely increase the amount earned on your savings account. If you have a fixed rate, however, base rate will have no impact on what you earn. Instead, your interest will remain the same for the remainder of your savings account’s term. This type of savings account is ideal if base rate is expected to lower because the fixed rate will not change over the agreed period.

If base rate is set to rise, then it might be worthwhile holding off on a fixed rate account or opting for a variable rate, such as an easy access account.

Alternatively, if you are in the market for a new fixed savings product, it might be wise to hold off on any firm deals if the base rate will rise.

If you are in the market for a new mortgage, it is important to consider the base rate. Conversely to savings rates, a base rate rise generally means you will start spending more on the cost of your new home rather than save.

A fixed rate mortgage, which keeps the interest rate constant over a certain period, is often preferred when base rate is expected to rise. This is because, like a fixed rate bond, the interest will be locked in at a lower level.

Likewise, if base rate is expected to fall, a standard variable or tracker mortgage could be considered. A tracker mortgage will move more rigidly with the base rate decision, which helps provide consumers with more predictability in their payments.

A standard variable mortgage, on the other hand, is influenced by base rate to a lesser extent. When looking for a standard variable mortgage, initial rates are set according to the lender’s discretion, not directly in line with the base rate. Fixed term mortgages which expire generally revert to the bank’s standard variable rate, which is why they tend to be higher than other rates on the market.

The interest on the majority of loans is not directly linked to the base rate. That said, many lenders still review the interest rates on their loans after base rate movement.