🔔 Ask Anna: How does the base rate affect savings rates?

I wonder if Savings Champion could explain to readers how changes in the base rate are supposed to flow through into bank mortgage and savings rates and why this appears to be broken with the August base rate rise.

The Bank of England states the following:

‘Bank Rate’ is the single most important interest rate in the UK. It is set by the Bank of England’s Monetary Policy Committee (MPC), normally eight times a year. It is sometimes called the ‘Bank of England base rate’ or even just ‘the interest rate’ in the news.

Bank Rate is the rate of interest we pay on reserves held by commercial banks at the Bank of England. For this reason, banks normally pass any changes in Bank Rate onto their customers. When we raise Bank Rate, they usually increase the interest customers have to pay on borrowing and the interest they earn on savings, and vice versa.

So an increase in Bank Rate makes borrowing money more expensive and saving more rewarding. And a decrease in Bank Rate makes borrowing cheaper and saving less rewarding. Higher interest rates mean people will spend less in order to service their debts and benefit from good savings rates. This puts downward pressure on inflation. When interest rates are lower, the opposite is true.

Of course, as you have quite rightly pointed out, whilst the Bank of England explanation makes sense, it is far from that simple!

Before the banking crisis in 2008, and the subsequent introduction of the Funding for Lending Scheme in August 2012, rates for existing savers were rarely cut outside a fall in base rate – but all that changed as soon as the lenders were given a cheaper source of funding for their loan book – and as a result they no longer needed to raise money from savers.

The knock-on effect was that best buy rates started to fall as providers tried to limit the amount of money that they attracted. This meant that the rates being paid on existing savings accounts were too competitive, so there began a torrent of rate cuts to existing savings accounts. This was the point at which the link between the Bank of England base rate and savings rates was well and truly severed.

Following almost a decade of no movement in the base rate, we still saw thousands of rate cuts to existing savings accounts. Now that the base rate has increased, one would hope that savings providers would do what is expected, but of course that is far from the case.

After the base rate rise from 0.25% to 0.50% in November 2017, 50% of variable rate savings accounts remained unchanged – none of the increase was passed on to savers in those accounts. And more of the same is happening this time around.

It’s a bit of a lottery as to whether you will benefit from any base rate rise – savers need to be aware that in this respect in particular, the savings market is broken. I’m afraid it’s up to you to check if your provider has played fair – and if they haven’t and you can earn more elsewhere, switch!

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