Why are Interest Rates So Low? (...and what it means for your money)

13 Apr 2022

Written by Shaq Magee, Co-Founder of Millennial Money UK

The COVID-19 pandemic and subsequent national and local lockdowns have led to UK interest rates reaching record low levels. In this article I explore what interest it, why it is currently so low and what this means for your money. We also have information about how Chip is able to offer market-leading returns on your cash savings.

This article is sponsored by Chip, provider of market leading savings returns account Chip+1. For exclusive access to Chip+1 click here and enter the code MMUK20 to unlock the 1.25% return on your cash savings.

 

What is interest?

Interest is the cost of borrowing money; paid to the lender by the borrower. This means when you borrow money from a bank as a loan e.g. a mortgage, you pay a percentage of interest on the amount you borrowed, therefore paying a higher amount back in total. When you deposit money into your savings account, you are essentially lending your money to your bank, which is why the bank will offer you interest on your savings. The cost of borrowing, or lending, money is usually expressed as an interest rate. The interest rates set by banks, for both borrowing (e.g. mortgages) and lending (e.g. savings accounts) are influenced by the Base Rate.

The Base Rate, or Bank Rate, is the interest rate set by the Bank of England (BoE). It influences the interest rates set by banks and its purpose is to help regulate inflation. The BoE Monetary Policy Committee meet every 6 weeks to discuss the Base Rate, however it can remain the same for years. After being dropped from 0.75% to 0.25% in March 2020, the Base Rate was then dropped further the following week to 0.1%, where it currently remains. When the base rate goes up, the cost of borrowing goes up e.g. mortgages, and you would expect to get a better return on your savings. When the base rate goes down, the reverse happens, the cost of borrowing goes down, meaning that getting a loan from your bank will be cheaper but you get lower returns on your savings.

 

Why does the Base Rate change?

The Base Rate is set up to help keep the UK’s inflation target of 2%. A low Base Rate encourages people to borrow money as it is less expensive for them to repay.  The theory is that the less you spend repaying debts, the more you can spend elsewhere, helping to grow the economy, subsequently causing inflation to rise. This theory is what has driven the record low 0.1% current Base Rate, discouraging people from saving their cash in an attempt to encourage spending and boost the economy. Alternatively, if the economy is growing at a fast pace, the base rate may be increased to encourage saving, discourage spending/borrowing and keep inflation down.

As an example, in 2007, the Base Rate was around 5.5%. The average variable mortgage rate was 7.5%. Fast forward to 2009, after the financial crisis, and the Base rate was at 0.5%. At this point, the average variable mortgage rate was around 2.5%.

 

What does this mean for my money?

Given that the Base Rate is so low, Banks have had to drop their interest rates in response. Previous best in class savings account providers have had to slash their rates, making them much less attractive to customers. An example of this is Marcus by Goldman Sachs’ savings account, who have cut their interest rate from 1.5% to 0.5% in the last 12 months.

We don’t know what the future holds but given the current climate, it’s fair to assume that interest rates won’t be shooting up anytime soon, so it’s important to make sure that you are maximising the returns on any cash that you are saving in the short term (less than 5 years) e.g. emergency fund, short term savings goals.

 

Chip+1

We have partnered with Chip to offer you access to Chip+1, an easy access savings account with a market leading return of 1.25%. Chip +1 will provide returns on all deposited funds up to £5,000 and is covered by the Financial Services Compensation Scheme (FSCS), meaning that your money fully is protected. Chip is an innovative Fintech company and unlike banks, operates in a more agile fashion, allowing them to react to new challenges, such as low interest rates as we are experiencing now.

Because of their agile nature, Chip are able to give Chip+1 users a 1.25% return in the form of a bonus. They can do this is because they have set aside a portion of their annual budget to give directly back to consumers via a market leading rate. This is some positive news at a time when the current market conditions are not beneficial to those who want to save. To get access to Chip+1 and the 1.25% bonus rate on deposits of up to £5,000, simply follow this link and use the code MMUK.
 


What are Negative Interest Rates

In October 2020, the BOE sent a letter to UK Banks asking them how ready they would be if the Base Rate dropped to 0%, or lower, into negative territory. While this is not a guarantee that the Base Rate will turn negative, it is useful to understand what a negative interest rate could mean for us as consumers.

Several countries central banks have adopted negative interest rates in recent years, including Japan, Switzerland, Germany, and Sweden. With a negative interest rate, returns on savings would be non-existent. Banks would not usually pass this negative interest rate on to everyday savers, as this would discourage them from using their services. The negative rate would therefore effect institutions and high value savers (In Germany those with over 100,000 euros). In theory, mortgages, and other forms of lending, could also adopt a negative rate, meaning that you would repay less than your original loan. Rather than the lender paying you, the outstanding amount that you owe reduces, accelerating how quickly the loan is paid off.

 

What Next?

The potential for negative interest rates further emphasises the need to find a suitable place to store your cash. No one knows for sure what will happen to interest rates in the coming months and years but it’s fair to assume that they will stay low for the foreseeable future. While this is the case, Chip+1 offers the best returns in the market and is a great option for getting a return on your savings, whether you are working towards a savings goal or have some money you want to set aside for the future. Remember to sign up using this link and the code MMUK for access to their 1.25% returns.