Select your language

Suggested languages for you:
Log In Start studying!
StudySmarter - The all-in-one study app.
4.8 • +11k Ratings
More than 3 Million Downloads
Free
|
|

All-in-one learning app

  • Flashcards
  • NotesNotes
  • ExplanationsExplanations
  • Study Planner
  • Textbook solutions
Start studying

Interest Rates in the UK

Save Save
Print Print
Edit Edit
Sign up to use all features for free. Sign up now
Business Studies

Profits in business always depend on the rate of interest: the higher the interest, the higher the rate of profit required."

- James Buchan

Interest rates are essentially the cost of borrowing money. As a result, when businesses borrow money, the reason they need to turn a higher profit is due to the interest payments they need to make on the borrowed money. Let's take a look at this concept in more detail.

Definition of Interest Rates

Interest rates can be defined as the cost of borrowing money.

When we (individuals) or firms borrow money, we have to pay a certain rate. However, if you deposit money in a bank you also receive interest on your deposit - the bank pays you interest when you store your money with them. In the UK, the Bank of England sets the base rate for interest. Currently, the official base rate in the UK is 0.1%.

If you borrow £ 1,000 from a bank and the base rate of interest is 0.1%, you would end up having to pay back £ 1,001. Similarly, if you deposited £ 1,000 you would receive £ 1,001 after a certain defined interest period.

Some common examples of where you would be charged interest are:

  • When you borrow money from a bank

  • When you have a credit card

  • When you have a mortgage

Factors affecting interest rates

Even though the Bank of England sets the base rate, many other factors could influence the actual rate of interest you are paying or receiving. For instance, if you are borrowing money, the rate of interest will depend on the term of the loan (how long it will take you to repay the money) and how risky the loan is. If there is a higher risk attached to your loan, then you will be charged a higher rate of interest. Credit risk comes from the borrower's perceived inability to repay the loan.

The base rate in the UK is currently quite low. It has been set at this low rate in order to encourage consumption and investment in the economy.

Monetary Policy and Interest Rates

Monetary policy is a type of government policy that influences an economy's interest rates or money supply to change the level of output in the economy.

The government can increase or decrease the rate of interest by changing the base rate of interest.

When interest rates are increased, it costs more to borrow money - so fewer people borrow. When interest rates are decreased, it costs less to borrow money - so more people borrow. This can directly impact a business's external environment.

A business's external environment includes many factors that the business does not have direct control over but can influence business decision-making (PESTLE).

Changes in Interest Rates

The influence interest rates will have on business decision-making depend on a couple of different factors.

Effects of an Increase in Interest Rates

If interest rates increase, people are less likely to borrow money. When interest rates increase, the cost of borrowing money is high but the return you get on saving money is also high. As a result, consumer spending on goods and services (consumption) will decrease - as people put off borrowing and save more. Investments will also decrease.

Small firms are often affected more by higher interest rates than larger firms. Small companies often rely more on borrowing money, as they have limited financial reserves. There is also a higher risk for banks when loaning money to a small firm, as they have fewer resources and assets - a higher possibility of them not being able to repay the loan. Substantial increases in interest rates could lead some smaller firms to bankruptcy.

Larger firms can also be affected by increases in the rate of interest. Like smaller businesses, large firms also borrow money, and often large amounts of it. If the company's rate of borrowing is high, a large increase in interest rates will lead them to have to pay large sums in interest payments. This could result in the businesses having to cut expenses in other departments, making them less competitive.

Finally, increasing interest rates also impact exchange rates. A higher interest rate in the UK will increase exchange rates, as more people and organizations try to buy GBP to profit from the high interest rate in the UK.

Effects of a Decrease in Interest Rates

If interest rates decrease, people are more likely to borrow money. When interest rates decrease, the cost of borrowing money is low but the return you get on saving money is also low. As a result, consumer spending on goods and services (consumption) will increase - as people are more confident in borrowing money and disincentivized from saving. Investments will likely also increase.

Similarly, a decrease in interest rates will also encourage business activity as investment increases. It becomes cheaper for firms to borrow money, reducing their expenses on interest payments, and increasing their investment in other departments or operations of the business. This could result in an increase in the competitiveness of the business.

Additionally, when interest rates are low, people are more likely to start new businesses - as the cost of borrowing money is lower.

Interest Rates in the UK - Key takeaways

  • Interest rates can be defined as the cost of borrowing money.

  • When individuals or firms borrow money, they have to pay a certain rate.

  • If you deposit money in a bank you also receive interest on your deposit - the bank pays you interest when you store your money with them

  • In the UK, the Bank of England sets the base rate for interest.

  • The official base rate in the UK right now is 0.1%.

  • Monetary policy is a type of government policy that influences an economy's interest rates or money supply to change the level of output in the economy.

  • When interest rates increase, the cost of borrowing money is high but the return you get on saving money is also high. As a result, consumer spending on goods and services will decrease and so will investment.

  • When interest rates decrease, the cost of borrowing money is low but the return you get on saving money is also low. As a result, consumer spending on goods and services will increase and so will investment.

Interest Rates in the UK

Currently, the base interest rate in the UK is 0.1%. In the UK, the Bank of England sets the interest rate. The base rate in the UK is currently quite low. It has been set at this low rate in order to encourage consumption and investment in the economy. 

It is quite complicated to predict whether interest rates will rise, as the rate of interest depends on a number of factors. Currently, the base rate has been set at 0.1% to offset the economic slowdown resulting from the pandemic. If the economy continues to grow, it is possible that the base rate of interest will increase. 

Final Interest Rates in the UK Quiz

Question

What is an interest rate?

Show answer

Answer

An interest rate can be defined as the price of borrowing money. It is also the benefit you get when saving your money in a bank.

Show question

Question

What is the base rate of interest in the UK? 


Show answer

Answer

Currently, the base rate of interest in the UK is 0.1%. 

Show question

Question

Why has the base interest rate been set so low in the UK? 


Show answer

Answer

The base rate has been set quite low in the UK in order to encourage consumption and investment.

Show question

Question

Name an example of when you would be charged interest. 


Show answer

Answer

When using a credit card or when borrowing money from a bank.

Show question

Question

What are two factors that would affect the interest rate you pay? 


Show answer

Answer

The term of the loan and the risk associated with your loan.

Show question

Question

What is monetary policy? 


Show answer

Answer

Monetary policy is a type of government policy that influences an economy's interest rates or money supply to change the level of output in the economy. The government can increase or decrease the rate of interest by changing the base rate of interest.

Show question

Question

Which of the following statements is correct? 


I. When interest rates increase the cost of borrowing money increases. 

II. When interest rates increase the cost of saving money increases. 

Show answer

Answer

Only statement I. is correct. 

Show question

Question

Small firms are often _________. 

Show answer

Answer

More affected by interest rates than larger firms. 

Show question

Question

An increase in interest rates could: 

Show answer

Answer

All the above answers are correct. 

Show question

Question

A decrease in interest rates is likely to: 

Show answer

Answer

Lead to an increase in consumption. 

Show question

Question

What is one of the outcomes of an increase in interest rates? 


Show answer

Answer

An increase in interest rates could decrease consumption and investment.

Show question

Question

What is one of the effects of decreasing interest rates?


Show answer

Answer

Decreasing interest rates are likely to encourage consumption and investment.

Show question

Question

When interest rates are low:

Show answer

Answer

New businesses are likely to emerge. 

Show question

Question

If you borrow £ 1,000 from a bank and the base rate of interest is 0.1%, how much would you have to pay back?

Show answer

Answer

You would have to pay back £ 1,001.

Show question

Question

What is the term of a loan?

Show answer

Answer

The term often refers to the repayment period.

Show question

Question

When interest rates increase, the cost of borrowing money is low.

Show answer

Answer

True

Show question

Question

You get higher return on saving money when the increase rate is high. 

Show answer

Answer

True

Show question

Question

Why are smaller firms affected more by higher interest rates?

Show answer

Answer

Small companies tend to borrow more money as they have limited financial reserves.  Substantial increases in interest rates could lead some smaller firms to bankruptcy. 

Show question

Question

What would happen if the interest rate in the UK increase?

Show answer

Answer

More people and organizations will try to buy GBP.

Show question

Question

People are more likely to borrow money when interest rates are...

Show answer

Answer

High

Show question

Question

Consumer spending on goods and services will increase when the interest rates are...

Show answer

Answer

High

Show question

Question

When would people rather save money than spend it?

Show answer

Answer

When interest rates are low

Show question

Question

Base rate is the only thing that determines the interest rate you are paying. 

Show answer

Answer

True

Show question

Question

 If there is a higher risk attached to your loan, then you will be charged a ... rate of interest. 


Show answer

Answer

higher

Show question

Question

When interest rates are increased, it costs more to borrow money, ... people borrow


Show answer

Answer

fewer

Show question

Question

Changes in interest rates have little influence on business decision-making.

Show answer

Answer

True

Show question

60%

of the users don't pass the Interest Rates in the UK quiz! Will you pass the quiz?

Start Quiz

Discover the right content for your subjects

No need to cheat if you have everything you need to succeed! Packed into one app!

Study Plan

Be perfectly prepared on time with an individual plan.

Quizzes

Test your knowledge with gamified quizzes.

Flashcards

Create and find flashcards in record time.

Notes

Create beautiful notes faster than ever before.

Study Sets

Have all your study materials in one place.

Documents

Upload unlimited documents and save them online.

Study Analytics

Identify your study strength and weaknesses.

Weekly Goals

Set individual study goals and earn points reaching them.

Smart Reminders

Stop procrastinating with our study reminders.

Rewards

Earn points, unlock badges and level up while studying.

Magic Marker

Create flashcards in notes completely automatically.

Smart Formatting

Create the most beautiful study materials using our templates.

Sign up to highlight and take notes. It’s 100% free.