Things that affect interest rates, and why they change

Interest rates get mentioned a lot, but they aren’t always fully explained. Yet they’re relevant to anyone who is borrowing or saving money. 

Simply put, interest is the percentage charged on the total amount you borrow, or earned on the total amount you save. Accounts that offer a service to save or borrow money usually have an interest rate, expressed as an annual percentage.     

For example, putting £1,000 into a savings account with a 1% interest rate would earn you £10 over the course of a year.

Why interest rates matter

High or low, interest rates are important because they influence the borrowing costs and spending decisions of consumers and businesses. While low interest rates can encourage people and businesses to borrow money for things like mortgages, big purchases, or investments, higher interest rates often do the opposite, and can restrain consumers and businesses from borrowing.   

Here are the few ways interest rates can affect our finances:

The way people spend money

In theory, if interest rates are low and people are paying less in interest, they have more money to spend, which can lead to a wave of increased spending throughout the economy.

And it’s the same for businesses. A lower cost of borrowing might encourage them to make bigger investments in equipment or services, which in turn boosts output and productivity and helps to lift the economy.

How much it costs to borrow money

High interest rates mean that businesses and people in debt will be paying more interest to lenders. This can result in consumers having less disposable income and buying fewer things. 

How much people save

When interest rates on savings accounts are higher, people also tend to be more likely to save, due to the higher rewards they’ll receive for keeping money in the bank. 

What makes savings interest rates go up or down?

Changes to UK banks’ saving interest rates do happen fairly regularly. This is because interest rates can be variable, and so can fluctuate depending on what’s happening in the economy.  

Some key factors include:

• Inflation
  Interest and inflation usually correspond to one another. Generally, the lower the interest rate, the more buying power the consumer can have. This can increase spending, which causes prices to go up – or inflate. If demand starts to outpace supply, interest rates may go up, slowing the amount of money flowing into the economy.
  
  
• Base rate
  In the UK, interest rates are influenced by the Bank of England base rate. If the base rate goes up or goes down, it can affect the savings rates that banks offer to customers – and ultimately how much interest you can earn on your savings.  
   
• Other banks or building societies changing their interest rates
  When some banks or building societies change their interest rates, other banks may find they need to follow suit. This is so they can manage the growth of their business in a sustainable way.

To find out more about inflation and interest rates, read our article here.