Saving the economy: Why lowered interest rates matter so much

by Josh Biggs in Finance on 22nd December 2020

With the global economy reacting to the storm of uncertainty caused by the COVID-19 pandemic, general trends in government and corporate response are emerging. Key institutions such as the Bank of England in the UK have continued to adjust interest rates in an effort to avoid a recession deeper than that which is already being experienced, but to what avail?

Most recently, the Bank has announced that a historic low of 0.1% is to be maintained for the UK, pinning its hopes that a combination of lowered interest rates and continued monetary support and grants for businesses and professionals will mitigate the damage already caused by COVID-19. 

Why do interest rates matter?

Whenever a person or business borrows money, there’s a small fee involved that is imposed by the person who is lending that money to you. These rates are determined using the base interest rate that is determined by the Bank of England. This rate is adjusted periodically through each year and acts as a way for the government to regulate the economy as it fluctuates naturally.

Importantly, the base interest rate is important for its use by banks in determining how much they pay to borrow money – and how much they charge their customers to borrow too. Generally speaking, a surging economy will see institutions like the Bank of England raise interest rates in an effort to avoid unsustainable periods of growth. And the opposite is true too; when we are experiencing significant economic stress and uncertainty such as is being imposed by COVID-19, the base interest rate is lowered in an effort to stimulate borrowing and spending among businesses and consumers.

The Federal Reserve responds

Overseas in America, the same story has been unfolding for some time prior to COVID-19. Already battling an effort to avoid an economic slump, the Federal Reserve lowered its interest rate target for the second time that year. Once more, this was done to stimulate spending by businesses and consumers and in key markets such as mortgages, home sales and consumer credit. 

And just as the Bank of England responded in 2020, so too did the Fed early in the year. Interest rates were cut again in a drastic decision that left the new rate close to 0%. 

Industry consequences

When we consider interest rates for businesses, lower is always better. A higher interest rate means that expansion costs more for a company, limiting their ability to grow and thrive. Comparatively, a lowered rate signals to the business world that it’s an ideal time to make key strategic expansion happen, often through obtaining funds via loans and banking institutions via financing. Many businesses will wait for a period such as this within which to make a significant move that will, should their efforts be successful, positively impact the economy as well as their own operation. 

The mortgage industry is a similar example of how interest rates affect the economy and spending trends. Vital to every country, home sales and mortgage figures are watched closely by experts and analysts who hope to draw predictions off past and current performance. 

Lowered interest affects home sales drastically because of the total amount of interest repaid over the course of a mortgage – often as much as 60% by the end of one. It’s good news for existing homeowners, too; when interest rates fall, the total interest paid in their monthly arrangements falls too. And as those on the ladder benefit, so too do new buyers who often wait for periods of low interest rates before making their move.

The path ahead

And so, we find ourselves in a period where governments are making drastic decisions to cut interest rates in an effort to support a faltering economy. With much hope now pinned on the rolling out of brand-new COVID-19 vaccines, it is hoped that these reductions to interest rates will boost the economy for consumers and businesses long enough for us to survive the worst the pandemic has to throw at us. The Everyday Loans teams hopes you’ve found this article informative and wishes you the best for the months ahead.

Categories: Finance