Worse than expected economic performance at the start of the year has led Bank of England’s Monetary Policy Committee to hold off on increasing the base rate above 0.5%.
The decision comes despite the Bank’s governor, Mark Carney, having earlier signalled that a rate rise was incoming soon.
What is the base rate?
The base rate is the “rate of interest [paid] on reserves held by commercial banks at the Bank of England”. It is, effectively, the fundamental interest rate on which most commercial interest rates on standard bank accounts and loans are ultimately based (though of course other things like risk will play a part when calculating interest on loans).
Higher interest rates favour savers rather than spenders, and lower interest rates favour spending and borrowing while making saving less rewarding. The Bank of England adjusts the base rate in accordance with the general economic climate in order to either encourage saving or spending with the general aim of maintaining a prosperous and stable economy.
Practically, this largely involves the Bank adjusting interest rates to try and keep inflation at, or as close to, a target of 2%. Higher interest rates exert downward pressure on inflation, and lower interest rates push it up.
Rates Held Steady
CPI Inflation currently sits at 2.3% and earlier predictions of solid economic growth through this year had led many to expect the Bank to vote to increase the base rate from 0.5%, where it has been for much of the past 8 years, bar a dip to 0.25% during 2017. However, at the same meeting during which the Bank’s MPC voted to hold interest rates steady, they also downgraded their forecast for the year’s economic growth from 1.8% to 1.4%.
This is largely down to a recent set of figures that showed that the UK economy grew by just 0.1% during the first quarter of 2018. Since an increase to interest rates tends to slow spending and borrowing and therefore reduce economic growth, the decision was made to hold interest steady for the time being.
The Bank remains fairly confident that this patch of reduced growth will be just that, a “temporary soft patch”, and that more prolonged improvement should be on the horizon. This is partly down to the assessment that part of the sluggish growth over the first quarter of this year was partly related to the bad weather when the ‘Beast from the East’ hit slowing down economic activity. Their forecasts for the year were reduced principally to take into account the lower than expected performance that has already been and gone – growth predictions for subsequent years remain unchanged.
Despite the modest and likely short lived nature of the slowdown, there are some signs that a rate hike might not come even at the next MPC meeting in June. Inflation has been falling a little faster than the Bank expected it to, and it is now expected to drop down to the target 2% within the next couple of years, regardless of any change in interest rates.