The interest rates, mortgage rates, borrowing rates, and savings rates in the UK are all directly impacted by the base rate of the Bank of England. It is this base rate that largely determines how much the banks and other financial institutions charge as interest to people who borrow money and pay as an interest to those who save.
Thus, when the base rate goes down, it has a positive impact on borrowing, which becomes cheaper, but saving yields lower returns too. With a low base rate, mortgage rates and interest rates drop; however, savings rates also plummet. A lower base rate makes borrowing cheaper, increases purchasing power and spending, boosting the economy and increasing inflation.
On the contrary, when the base rate rises, borrowing becomes expensive. Mortgage rates and interest rates go up. Savings rates benefit from a rise in the base rate, too; however, the people end up paying more interest on their loans and mortgages. In turn, a higher base rate curbs the purchasing power and helps to stop inflation going beyond a sustainable level.
Therefore, the ultimate aim of the Bank of England’s base rate is to keep inflation at an optimum level of around 2%. The Monetary Policy Committee of the Bank of England reacted to the coronavirus crisis in the UK by lowering the base rate to a historic low of 0.1% in March 2020, where it remains today. The move was aimed at controlling the economic shock to the country and is expected to remain the same for the foreseeable future. It is predicted that the UK economy will shrink by around 11% by the end of 2020; therefore, the base rate may even go into negative territory to counter the impact of coronavirus and the global growth slowdown on the economy.
Brexit and interest rates
Brexit has been a game-changer for the UK’s economy right from the word go. The EU referendum – or, to give it its full name, the United Kingdom European Union membership referendum – took place in June 2016, with the UK voting to leave the EU. Shortly after the EU referendum, the value of the UK currency plummeted to its lowest point in over 30 years, and the UK economy suffered a massive blow. It was the first time in seven years the bank of England cut the base rate in half, from 0.5% to 0.25%.
Now, after extensive and elaborate discussions, the departure of the UK from the EU has been completed. Brexit will bring with it numerous uncertainties and will affect trade, tariffs, prices of goods and services, public finances, and the overall strength of pound sterling relative to other currencies. It will also have a substantial impact on stock markets, performance of UK public companies and investments. Most of the volatility will likely be short-term and the economy will absorb these changes sooner rather than later; however, consumers and investors should be prepared for a downturn and its repercussions.
How Brexit will impact interest rates will depend on the base rate determined by the Bank of England, as it is the base rate that changes mortgage rates, borrowing rates, saving rates, and interest rates. So, to determine if Brexit will impact interest rates, the first step is to understand if Brexit will affect the base rate. Nothing is certain, but past events can serve as precursors.
With the protracted discussions about the exit of the UK from the EU with a trade deal, it is positive a no-deal Brexit was avoided, which would have seen the pound sterling plummet sharply and the exchange rate become poor. Additionally, severe trade issues between the UK and the EU would have impacted growth and productivity, with businesses likely to have required government support to survive.
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In such a scenario, the Bank of England might have been forced to cut down the base rate to somewhere around -0.1% in the middle of 2021 to boost the economy and curtail inflation. The UK government will try its best to meet the inflation target by other means, including pumping extra money into the economy. Even with a trade deal secured, the government may have to work hard to keep the economy moving.
How to prepare for interest rate changes from Brexit
The base rate in the UK will most likely see changes as a result of Brexit. This change could go either way, though a reduction looks more probable. In either case, any change to the base rate will impact UK consumers substantially. Consumers must shop around and identify the best-in-market rates for their savings, mortgages, and other loans.
If interest rates go down, this is generally good news for UK consumers. Borrowing will become cheaper and the mortgage rates will go down. As a result, consumers will be required to pay lower interests on their loans and have the option to re-mortgage. UK consumers can prepare for an interest rate reduction by transitioning from a fixed-rate mortgage to a variable-rate mortgage to be able to reap the benefits of lower interest rates. On the flip side, the rate of returns on savings will also go down, so consumers might need to pay money to their banks to hold their savings. The situation can be salvaged by shifting to fixed-rate savings accounts that guarantee returns even if the savings rates turn negative.
On the contrary, if the interest rate climbs up, the returns on savings accounts will increase while borrowing will become more expensive. Any UK consumers worried about the rise in mortgage rates can transition to a fixed-rate mortgage and remain unaffected by any sharp rise in borrowing costs. The ones already on a fixed-rate mortgage should stick to their current deals to ward off any uncertainty and ensure that their mortgage rates do not hike if the government decides to increase the mortgage rates.
So, in either case, it is necessary for UK consumers to prepare themselves for some potentially impactful changes in interest rates. The most critical step towards preparation is to have an emergency fund to dive into if the situation becomes unfavourable. People can prepare themselves for the future by securing their interest rates, savings rates, and mortgage rates – this goes some way to eliminating as much uncertainty as possible.
The bottom line is that Brexit is likely to impact interest rates in the UK. Whether they go up or down is difficult to predict. However, considering the present circumstances, interest rates will most likely be cut as a result of Brexit to absorb the shock of the exit on the economy. Several economic indicators point towards a further cut in interest rates, including low levels of inflation, high levels of unemployment and a continuing slump in the UK economy.
Post-Brexit, aspects of the UK economy may require government support. Inflation levels in the country have fallen sharply in recent months, and they still remain below the official target, with the UK undergoing its first recession since 2009. The unemployment rate in the UK stands at 4.9%, the highest it’s been in the past four years.
As a result of the challenging circumstances, it is most likely that interest rates will go down as a result of Brexit. The government intends to facilitate growth in the economy by expanding its bond-buying programs and injecting billions of pounds into the economy. Still, slashing the interest rates may still be necessary. Whatever happens, it is certain that Brexit will mark an interesting and never-before time in the history of the EU and the UK.