The Bank of England is likely to cut interest rates over the summer to cushion the blow to the economy from the Brexit vote, its governor, Mark Carney, has indicated.
The Bank's key interest rate – called the ‘base’ or ‘repo’ rate - is its chief tool of monetary policy. Base rate is currently at a record low of 0.5%, where it has been for more than seven years since being cut in response to the global financial crisis of 2008.
A cut in interest rates, to 0.25% or even 0%, would have a knock-on effect on savings rates, and makes the pound a less attractive currency to hold and do business in.
Those who want to remain in the safe haven of cash need to be proactive, making their savings work as hard as possible. Savers should check that they are in a market leading account to lock in higher rates before any cuts. Continue to shop around for the very best rates you can find, which may include high interest current accounts or fixed rate bonds, in order to access better rates.
What exactly did Mark Carney say?
Making his second speech since the UK's vote to leave the EU, yesterday afternoon Mr Carney said: "In my view, and I am not pre-judging the views of the other independent Monetary Policy Committee (MPC) members, the economic outlook has deteriorated and some monetary policy easing will likely be required over the summer.
“I can assure you that in the coming months the Bank can be expected to take whatever action is needed to support growth subject to inflation being projected to return to the target over an appropriate horizon, and inflation expectations remaining well anchored.”
When will rates be cut?
On the day that the Brexit vote was announced, several market commentators told Moneywise that they expected interest rates to be cut soon.
The Bank will update its forecasts and make a full assessment of the economic picture in its August Inflation Report. Ben Brettell, senior economist at Hargreaves Lansdown says: “This probably leaves August as the likeliest date for a rate cut, though swap markets are pricing in a July cut as more likely than not (a 57% probability), and a 73% chance of a rate cut by August.
“Mr Carney and his MPC colleagues could face a delicate balancing act over the coming months, balancing higher inflation caused by the weaker pound with the need to stimulate growth. If history is anything to go by, growth will be the priority – remember the Bank was willing to ‘look through’ elevated inflation in the first phase of the financial crisis and cut rates to their current lows.”
How are interest rates set?
The Monetary Policy Committee of the Bank of England, meets every month to decide whether the interest rate should be changed. The committee members try to keep inflation close to 2% (between 1% and 3%).
If inflation goes above the target (or is forecast to rise above the target) then they will increase interest rates. Higher interest rates increase the cost of borrowing and make saving more attractive. This tends to reduce consumer spending and investment and reduce the growth of aggregate demand. Therefore, economic growth tends to slow down and this reduces inflationary pressure.
If inflation is below the target, then they may cut interest rates to boost spending and economic growth.
As well as trying to target inflation, the Bank of England looks at other aspects of the economy. It considers the impact of interest rates on economic growth and unemployment.
Therefore, it is possible that inflation can go above target, but the MPC feels it needs to keep interest rates low to support growth of the economy.
Banks do not have to follow the Bank of England rate decisions. They can set their own interest rates. However, the Bank of England base rate tends to influence all the main saving and borrowing rates in the economy.