Interest rates: how a small change can have a big impact

Managing the ups and downs of interest rates and what they could mean for your business.

This article was originally published on 25 October 2023. The article was republished on 14 March 2024.

How are interest rates calculated?

They’re the cost of borrowing or the reward for saving; if you have savings, a percentage of your savings will be paid back into your account. This percentage is calculated on a daily, monthly or annual basis, depending on the agreed terms.

Around every six weeks the Bank of England Monetary Policy Committee (MPC) meets to set the underlying Bank Rate, which influences other interest rates. 

It is the single most important interest rate in the UK, its aim is to meet the target that the Government sets to keep inflation [how quickly prices for goods and services rise] low and stable.

Mark Thomasson
NatWest Treasury Markets

These changes filter down to the commercial banks used by businesses and the public. These banks will usually alter interest rates on saving and borrowing to align with this rate, although only after considering their own costs of financing or balancing depositors and borrowers. 

How are savings/deposits rates linked with Bank Rate?

See below for a clearer picture of how Bank Rate has changed in the last few years alongside gross domestic product (GDP) economic growth, as well as the bank’s future predictions. 

Interest rates and GDP from 2017 to 2024

How might falling interest rates affect deposits?

As the economic cycle turns, interest rates are likely to stabilise before being lowered. The graphic above shows how this can be cyclical and why it helps to keep an eye on market conditions and what’s forecast for upcoming years.  

“As the Bank Rate falls, commercial banks will look to reduce both the rates paid on deposits and those charged on lending,” Mark says. “Each bank will have its own appetite for funding based on its balance sheet make-up, the need to fund assets and available sources of funding.

“If you have a loan or a mortgage these interest payments could fall, but if you have savings you may be paid less interest,” says Mark.

In a falling rate environment, whilst businesses can benefit from higher rates for shorter term deposits, they might compare the benefits of locking in an interest rate longer term, noting the impact of central bank rates continuing to fall over a prolonged period.

What are the differences between fixed and floating rate deposits?

Fixed rate: This pre-agreed interest rate is constant for either the entire life of the product or for a fixed term (time). Whether interest rates go up or down, your pre-agreed rate will remain the same.

Floating rate (also called an adjustable or variable rate): This changes according to the benchmark rate that it’s linked to, such as the Bank of England Bank Rate or the Sterling Overnight Indexed Rate (SONIA). This means it moves up or down depending on market conditions.

So a fixed rate loan taken out at the beginning of 2022 would be substantially lower than a similar product taken out now when the interest rate is at 5.25%. A variable rate loan would have risen during the last year but will start to fall once the Bank Rate begins to drop.

Equally a fixed rate offered on a deposits account in early 2022, when the Base Rate was around 0.5%, is likely to have been lower that at the current time, and would not have increased along with the Bank Rate. However, a variable savings rate would have usually risen during the last year, therefore earning higher interest.

How should businesses adjust their growth strategy?

As consumers have grappled with higher rates on their mortgages and borrowing over the past year, they will have less disposable income – which might also affect a business’s sales and revenue. Here are some tips which might help take advantage of higher rates:

Where do we think Bank Rate will go in 2024?

"Our central scenario is that the Bank of England cuts rates by 100bp (1.0%) in 2024 – with a cut of 0.5% in August and 0.5% in November,” says Imogen Bachra, our Head of Non-Dollar Rates Strategy. “Still-high – and sticky – services inflation and a tight labour market will make the Bank of England’s Monetary Policy Committee (MPC) cautious about cutting rates too early. But holding rates at the current high levels for longer means that when cuts arrive, they could be in slightly bigger increments than the usual 25bp."

For further information on financial health, visit our Cost of Living hub.

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