Interesting Economics

You may have heard on 4th August that the Bank of England cut interest rates from 0.5% to 0.25%. Hardly the most exciting news you’ve ever heard, or is it?

What does it mean?

The rate cut will probably effect you in two different ways — one good, one bad.

The Good — Firstly, it means that if you are borrowing money, let’s say your mortgage (and it isn’t a fixed rate mortgage) then the interest you are paying should have dropped by 0.25%. So for example, if you’re mortgage is £150,000 you will save £375 per year of interest, or £31.25 on your monthly repayment. As a famous retail shop says, “Every Little Helps!”

The Bank of England produced this infographic to explain why it’s good for you!

The Bad — Your bank account is probably paying you a little bit of interest. The effect of this drop means that in the near future you can expect it to pay you even less. If you are saving for something in particular, it’s going to take a little longer to reach your target. If you are just saving for the long term, your money will grow by less, and as usual, inflation should be higher and what that money can buy today isn’t going to buy you the same thing in 10 years. My classic example, and one I think I’ve used before, is the 500ml drinks you can buy. When I was going to school, a bottle of Coke (other drinks are available) would have set you back 70p. Nowadays, it’s more like £1.35. Trust me, if your 70p was in the bank all that time, you couldn’t afford the drink today.

The first rumours are starting to emerge about banks cutting interest rates. The one that caught my attention is the Santander 123 account. This account, as well as providing cashback, has been offering 3% interest on balances between £3,000–20,000. However, from November, this is being cut in half to 1.5%. Is this the end of Santander’s current account dominance? Possibly. An interest rate cut in half, and the monthly fee more than doubling to £5pm in one year could spell danger.

Why did they cut rates?

The Bank of England and the Monetary Policy Committee decided to cut rates as they are unsure of the economic strength of the UK after the Brexit vote. They are worried that we will drop back in to a recession and so have taken measures to prevent this.

Quick Economics Lesson:

A Recession is two consecutive quarters of a decline in GDP (economic output of a country). In basic terms, it is whether an economy makes more money than it spends, and we can’t officially be in recession until we have been losing money for 6 months. There are two ways to stop a recession:

  • Spend Less by saving (The economic cuts which David Cameron and George Osborne imposed)
  • Spend more to make more (the decision which has been made this time around)

The government is buying up government bonds to inject money into the UK economy. By reducing savings rates it makes saving less attractive, and so more people will spend money. So if businesses have money to spend, and households have money to spend, the idea is we spend in local companies, they make money and so businesses grow, employ more people, and all is right with the country.

Check out this video by Open University which explains the two approaches

So in summary, the interest rate drop is more of an issue for the UK economy as a whole, and the effect it has on you personally might not be so great. But if you don’t want to make even less than the few pennies your bank account is currently making you, maybe it’s time to start thinking about investing, to at least have a chance to grow your money long term.