Raising interest rates: so what? What does it mean for my finances?

Raising interest rates: so what? What does it mean for my finances?

The Bank of England, the UK’s central bank (also known as the BoE), raised interest rates from 0.5% to 0.75% on August 2nd.

It has been all over the headlines, but so what? What’s changed for the average millennial? Firstly, let’s consider why the BoE changes interest rates – the cost of borrowing money - at all.

What does a raise in interest rates mean for millennials?

How is a change in interest rates decided?

The Monetary Policy Committee (MPC) at the BoE aims to ensure inflation (an increase in prices and fall in purchasing power of money) reaches the target set by the government, mostly by changing the official interest rate, known as the Bank Rate.

The MPC is made up of nine members – the governor (Mark Carney), the three deputy governors (for Monetary Policy, Financial Stability and Markets and Banking), its chief economist and four external members appointed directly by the Chancellor of the Exchequer. 

The group meets eight times a year to vote on what Bank Rate to set. Currently the inflation rate is 2.4%, with a target of 2.0%.

Central banks such as the BoE try to affect spending habits when they tweak interest rates. Interest rates influence the overall level of activity in the economy.

If interest rates are very high then we’re more likely to save money, because banks will pay us to do so. When people spend less that tends to reduce inflation.

If inflation looks likely to fall below target, the BoE would probably cut interest rates to boost spending in the economy and help inflation to rise.

The next time the MPC is due to vote on the Bank Rate is September 13 2018.

What will the increase from 0.5% to 0.75% mean for my finances?

Generally a rise in the Bank Rate is good for savers and bad for borrowers.

The extra 0.25% a year on your savings might not immediately inspire you to save an extra fifty quid instead of spending it on a big night out (12p a year isn’t an amazing incentive), but when you’ve got a mortgage or other debts, interest rates can really make a difference.

Tracker mortgages match interest rate changes. More than 3.5 million residential mortgages are on a variable or tracker rate. A rise to 0.75% is likely to increase the annual cost of a £150,000 variable mortgage by £224 per year.

Other personal loans, debts and credit cards may have their interest rates changed by the provider, even if not straight away.

Banks and building societies wanting to increase their savings deposits could increase their rates too, in theory. Although, after November’s increase – from 0.25% to 0.5%, the first rise in more than 10 years – banks only passed on a fraction of the rise to savers.

It might feel like nothing has really changed overnight for some people and the hype around interest rates is more symbolic than anything. I see the small tweak in the system as a sign of confidence from the BoE that the future is looking more prosperous, but a series of small tweaks does soon add up.

 

Read more: Now that we're officially overspending, we need to swap FOMO for JOMO

Read more: Five ways to get the information and advice you need to take control of your finances

Read more: Two-minute guide: how big is Britain's national debt -  and should you worry?

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