The Bank of England will soon call for a cut in interest rates. Such a decision would have a monumental impact for both borrowers and savers. At the moment, the interest rate is 10%, so for every £10 they take out, they’re paying back £11. This £20 figure incorporates the original £10 you borrowed, too. It then heaps on an additional £1 just for the interest they are charging on that loan.
When interest rates go down, the cost of borrowing is cheaper. Take for example, when the Bank of England has made a policy rate cut in recent months—consumers and firms would end up paying lower interest rates on their debt. This change would tend to promote additional borrowing, spurring new economic activity as consumers and businesses spend on new products, services or in business growth.
The importance of the relationship between interest rates and saving behavior must not be understated. Usually when interest rates go down, the interest people earn in savings accounts goes down as well. This adjustment could make it more appealing for savers to reconsider their long-term financial plans. Having less to earn on interest, they will have less incentive to stay in neotraditional deposit products.
This expected rate cut comes as the U.S. continues to grapple with issues related to economic recovery and inflation stabilization. For one, doves argue that further cuts to interest rates would stimulate consumption and investment. They caution that this will be damaging to savers, who will receive lower returns on their deposits.
In real-world terms, it’s all about how interest rates affect the incentives to borrow or save. For instance, if you take a loan of £10 today at the 10% interest rate, in practice, after some time you will repay £11 in total. That £1 interest represents only 10% of your original loan amount. If this rate is lowered, borrowers will save money and have money to spend elsewhere. On the other hand, savers may have to adjust their interest income expectations.