Interest Rates

Are a charge paid by borrowers to lenders. Interest rates in the UK are based upon the Base Rate which is set monthly by the Monetary Policy Committee (MPC) of the Bank of England. The MPC are a team (of nine) assembled by the Bank of England to take monthly decisions on the base rate, which heavily influences other interest rates in the UK. The Base Rate acts as an indicator which other interest rates in the economy are set around. 

When the base rate goes up, the purpose is to counter inflation. Higher interest rates mean that mortgage interest payments will go up for many house buyers. In addition to this rising interest rates are taken as a sign that economic conditions will grow more difficult, making people less optimistic, causing large purchases to be postponed or cancelled as they are usually funded by borrowing. The overall effect of higher interests rates will be to reduce the aggregate demand (AD), which is a measure of all spending in the economy by consumers, firms, government and overseas buyers of export.

When the base rate goes down the purpose is to increase the demand and activity in the economy by businesses and consumers, which is generally done when there are signs of the economy going into a recession. This known as monetary policy which is when the use of the Bank of England base rate is to influence economic and business activity, targeting 2% inflation by the consumer price index.