plonkee money an english-er's thoughts on personal finance

November 22, 2007

what is the Bank of England base rate and why is it important?

Filed under: banking and economics — plonkee @ 12:00 pm

If you keep up with the news, especially the business news, you can’t fail to notice the interest that surrounds the announcement of any Bank of England base rate change every month.

I knew that the rate used to be decided by the Chancellor of the Exchequer, but is now decided by a committee. I also knew that if the Bank of England rate changes, so do the rates for both borrowing and saving at high street banks and building societies (the ones that you and I are most likely to use). But, what exactly is it, and why does have the effects that it does?

The Bank of England interest rate is the rate at which the Bank lends money to high street banks.

In the normal run of things, high street banks can’t keep enough money on hand and they have to get some from elsewhere, so that they can lend money to customers and so on. Most of the money they need comes from people with deposits with them, but the system is such that they tend to run short on daily cash flow.

Since the Bank of England prints most of the currency, they essentially control the money supply, and eventually, someone will have to come and ask them to for money. This means that the Bank of England interest rate drives all the other English banks.

how it works, simplified

If you want to borrow some money from a high street bank, it will have to borrow some of that money from the Bank of England. If the interest rate it gets from them is, say 5%, then in order to make a profit, it needs to charge you a little more that, say 5.25%.

Savings accounts rates tend to be a little bit lower from the Bank of England interest rates, say 4.75% in this example, because there are costs involved in running savings accounts.

If you want to know more, you can look at the Bank of England website.

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