Base rate definition
What is a base rate?
A base rate is the interest rate that a central bank – such as the Bank of England or Federal Reserve – will charge commercial banks for loans. The base rate is also known as the bank rate or the base interest rate.
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While commercial banks are free to set their own interest rates for borrowing, the rates that they charge on loans and offer on savings tend to be derived from the base rate.
This means that central banks can use base rates to encourage or discourage consumer spending, depending on the state of the economy.
How does the base rate affect interest rates?
The base rate will impact the interest rate that consumers receive, because commercial banks will alter their interest rates in line with any changes put out by central banks. If a central bank increases the base rate, commercial banks will increase their interest rates and borrowing becomes more expensive. If the base rate falls, commercial banks will decrease their interest rates and spending is likely to increase.
How can base rate changes affect you?
If a central bank reduces the base rate, banks would also likely reduce their lending rates and rates for mortgages. This means that it might be easier to get a loan, and mortgage rates would become more favourable for buyers. However, lower base rates could also mean that you would get lower returns on your savings, as interest rate payments decline in value.
If a central bank increases the base rate, borrowing would become more expensive and mortgage rates would increase – which is more favourable for the banks and for sellers. However, any savings that are held in interest-based accounts would see greater returns on the interest payments in line with the increase in the base rate.
In the years after the 2008 financial crisis, for example, many central banks kept base rates low. This in turn led most commercial banks to charge low interest rates on loans to customers, but also offer low interest rates on money held in interest-based accounts.
With the cost of borrowing low and the benefit from saving minimal, consumers would, in theory, be encouraged to spend money instead of saving it. This in turn would boost businesses and the economy.
Central banks release regular statements detailing their policy on base rates. See when the next release is on our economic calendar.
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