Where next for interest rates?

Before the economic downturn, few people paid much attention to the base rate - the official rate of interest set by the Bank of England's Monetary Policy Committee (MPC). Despite the group of economists meeting each month to discuss and vote on whether the rate should rise, fall or stay the same, the outcome rarely made much of an impression - it certainly was very rarely front page news.

But since October 2008, when the MPC first starting to aggressively cut the base rate, the story has become a lot more interesting. We've seen the base rate fall from 5% to just 0.5% - an all-time historical low. At the same time, many tracker mortgage borrowers have been reaping the benefits, while variable-rate savers have seen their interest rates fall.

The fact that the Bank of England has frozen the base rate for April and May shouldn't come as a huge surprise - after all, as the rate can't turn negative, it didn't have much scope for another cut.

At the same time, the latest inflation figures show that one measure of the cost of living, known as the Retail Prices Index (RPI), turned negative in March for the first time since 1960. It is now -0.4%, down from 0% in February.

The Consumer Prices Index (CPI) – the official measure of inflation that, unlike the RPI, does not include mortgage interest payments – also fell in March to 2.9%, down from 3.2% in February and 3% in January.

When inflation is high or rising, the Bank of England tends to increase the base rate to cool spending, as it becomes more expensive to borrow. When it falls, the base rate should also reduce - however, at the moment this is unlikely to happen as it cannot turn negative and there is little room for further cuts.

Some experts believe that inflation will rise in the months ahead, largely as a result of quantitative easing measures (the Bank of England increasing the amount of money in supply).

Alongside deciding to hold the base rate in May, the Bank of England also announced that it will increase the supply of new money by £50 billion to £125 billion.

But other experts argue that deflation (where prices fall rather than rise) is on the cards. 

Charles Davis, economist at the Centre for Economic Business Research, says: “Inflation is likely to reach its lowest level since monthly data began in 1949 in the coming months.”

Stick or twist?

A recent Moneywise poll revealed that 69% of users expect the base rate to be between 0.5% and 2% by the end of the year.

However, 15% believe the Bank of England will increase the rate to between 2% and 4%, compared to 12% who think it will cut the rate to less than 0.5%. A further 1% of users think the base rate could rise beyond 6% by the end of the current year.

The truth is, without the aid of a crystal ball, it’s hard to know exactly where the base rate is heading. Much depends on inflation, and until the economists that make up the MPC get a clearer picture of whether this is increasing or slowing, the interest rate is far from set in stone.

As well as waiting to see what happens to inflation, the Bank of England is also likely to be waiting to see more evidence of the impact of monetary measures already taken.

The central bank says quantitative easing will take three months to take effect.

Adrian Coles, director-general of the Building Society Association, says: “With the general economic outlook remaining bleak, we hope that the expansion of the quantitative easing programme will help to lessen the severity of the downturn.”


Official figures from the Bank of England reveal that rates on instant access, notice and fixed-rate accounts saw a slight uplift in March – but remain depressingly low.

Instant access deals, for example, now pay on average 0.19%, up from 0.16%. However, this is still a far cry from the average rates seen last March of 2.47%.

Fixed-rate deals have also become slightly more competitive, with average deals now paying 2.65%, up 0.02% from February. Again, however, they pay significantly less than last year, when average rates were around the 5% mark. Notice accounts, meanwhile, remained stagnant at 17% between February and March – down from 3.42% last year.

Despite the slight uplift on fixed and variable-rate accounts, cash ISA savers have little cause for celebration – rates actually fell in March, from 0.96% the previous month to just 0.63%. This means that in the past year, rates on cash ISAs are down a whopping 4.18%.

Savers have been hit particularly hard by the rapid decrease in the base rate. According to data provider Defaqto, 60% of instant access savings accounts now pay less than 0.5% on a £1,000 balance - and 50% pay less than 0.25%.

As a result, people's savings are now barely able to keep up with inflation, and could even be eroding in value rather than growing.  James Caldwel, director of Fairinvestment.co.uk, says pensioners are the worst hit.
"This time last year, pensioners were enjoying interest rates on their savings that were 10 times what they are now, when the base interest rate stood at 5% - now the average no-notice savings account has a rate of just 0.65%," he adds.

Low interest rates are also bad for banks and building societies. Coles explans: “While hard-pressed savers should see interest rates maintained, this decision does nothing to help lenders to attract new deposits that could be used to fund mortgage lending."


While some tracker mortgage borrowers have benefited from the falling base rate, lenders like Nationwide have 'collars' in place which prevent rates from falling below a certain level. So, with each base rate cut, fewer borrowers have benefited.

At the same time, people with fixed-rate mortgage deals have seen no change to their monthly repayments. Those on their lenders' Standard Variable Rate may also have seen no change, as many lenders have chosen not to pass on the base rate cuts in full - if at all.

New mortgage deals, however, are cheaper but only for people with big deposits to put down. Figures from data provider Moneyfacts show that two-thirds of mortgages currently on the market require buyers to put up a deposit of at least 25%.

However, if you’ve got your eye on a best-buy mortgage deal, then you’ll need to stump up at least 40% upfront.

The decision to freeze the base rate in April won't benefit borrowers - but it is also unlikely to make things tougher for them either.

However, Andrew Montlake, director of independent mortgage broker Coreco, is concerned that when the base rate does start to go up again (as it inevitably will) borrowers with loans that track the base rate will get a shock.

"There is growing concern that inflationary pressures will ignite a series of sharp rate hikes later this year and on into 2010," he explains. "With house prices still likely to be low when rates do start to rise, many homeowners will be at the mercy of higher interest rates without being able to remortgage because of insufficient, or negative, equity."