Between December 2021 and August 2023, the Bank of England (BoE) increased interest rates 14 times in an attempt to control spiralling inflation.
Now that the inflation rate has fallen back to the BoE target, the bank’s Monetary Policy Committee (MPC) has narrowly voted to reduce the base rate for the first time in four years. Moreover, many commentators expect the BoE to cut rates further in late 2024 and 2025.
Read on to find out more about why interest rates change, and how this recent cut could affect your mortgage, savings, and investments.
The Bank of England has cut rates as inflation returns to the 2% target
Changes in the base rate affect how much people and businesses spend, and this influences the price of goods and services. Consequently, interest rates are a key tool the BoE uses to control inflation in the UK.
As inflation rose to a 40-year high of more than 11%, the BoE increased rates with the aim of reducing consumer spending. This, in turn, was designed to reduce the demand for goods and services, slowing the rise in prices.
Now inflation has returned to the BoE target of 2%, many experts expect interest rates to start falling. The MPC meets eight times a year to set interest rates and, in August 2024, announced the first cut, from 5.25% to 5%, in a narrow 5-4 vote.
Assuming inflation remains under control, the base rate could fall further at the remaining three MPC meetings in 2024, and in 2025.
A lower base rate could mean cheaper mortgage payments
If you have a mortgage, a cut in the base rate could result in lower monthly repayments – although this will depend on the type of mortgage you have.
Fixed rate
If you’re on a fixed rate, a base rate cut won’t immediately affect your monthly repayments. However, when you come to renew, you may be able to benefit from a better deal if interest rates have fallen.
Tracker rate
If you are on a tracker rate, a cut in the base rate will usually mean an immediate cut in your mortgage rate. For example, the 0.25% reduction in the base rate should result in your mortgage rate being cut by 0.25%.
Variable rate
If you’re on a discounted variable rate, or your lender’s standard variable rate (SVR), your monthly repayments may fall as a consequence of the rate cut. While lenders typically change their SVR in line with BoE interest rate movements, they are not obliged to.
A side effect of lower interest rates can be an increase in housing demand, as mortgages become more affordable. So, as rates fall, you may see the value of your property rise.
You could see savings rates fall
In recent months, interest rates on savings accounts have been higher than they’ve been for much of the last decade. As you can see from the chart below, the base rate has outstripped inflation for much of 2024.
Source: BBC
When the interest rate you receive is higher than the rise in the cost of living, you benefit from real-terms growth on your cash.
However, as the Bank cuts the base rate, banks and building societies will likely reduce the rates on their savings accounts. This could make cash savings less attractive for building your wealth and beating inflation.
As rates fall, you could consider:
- Shopping around for the best savings rate and switching your savings as appropriate
- Making the most of tax-efficient savings such as a Cash ISA where all interest is paid free of Income Tax and Capital Gains Tax (CGT)
- Tying up cash you don’t need immediate access to in a fixed-term bond.
If you’re building wealth over the long run – typically over a time horizon of more than five years – you could benefit by moving some money from cash savings to investments.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances. They can fluctuate in value, but over the long run, they could give you the potential for an inflation-beating return.
Again, you could consider a tax-efficient vehicle such as a Stocks and Shares ISA where all gains are free of CGT, Dividend Tax, and Income Tax.
Remember that the value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Cheaper borrowing can be good for the stock market
A diversified investment portfolio can be a powerful way to help you achieve your long-term goals.
A base rate cut could provide a welcome lift to the stock market, where some of your portfolio is likely to be invested. This happens due to three primary mechanisms:
- Lower interest rates make borrowing cheaper for businesses, and this can result in more investment and growth.
- Cheaper debt repayments mean consumers have more disposable income to spend on goods and services, boosting business revenues and profits.
- Lower interest rates also mean people are more likely to borrow to buy big-ticket items, increasing consumption.
If you own or run a business, you may welcome the base rate cut as it could reduce the cost of any commercial loans you have, and any debts you service.
Get in touch
If you have any questions about how cuts in the base rate could affect the progress towards your long-term goals, speak to us now.
Please contact us on info@janesmithfinancial.com or call 01234 713131.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.