Re: Bank of England Interest Rates

How does the Bank of England interest rate work and how does this determine

> High Street bank interest rates ? Do the B of E interest rates have > any connection with Government gilt yields ? Please explain ! Thanks.

Interest rates are used as a tool for managing inflation and the economy as a whole. Basic economics (ie, supply and demand). If the economy starts to overheat, interest rates are increased and continue up until the economy slows down and then they start going the other way (slowly) in order to prevent pushing the economy into recession. Timing is crucial and I suspect any Government is a poor judge, hence probably why the BoE was made independent of Government when Labour came to power. It may be coincidence that the UK has managed to have the longest sustained length of growth in recent history with a recent gentle drift downwards.

Bank and building societies set their interest rates on a commercial decision based on their own cost base. The more expensive the rate then probably the more expensive (and perhaps even inefficient) the lending organisation. You usually find the older, longer established financial services organisations charge higher interest rates for loans, mortgages, etc. whereas the new kids on the block (ie, internet based banks), can offer low rated borrowing rates because there costs are lower (or they're just more efficient). It works in reverse for savings rates.

I wouldn't think any bank could sustain indefinitely to match the BoEs base rate for borrowings or savings because they wouldn't generate any margin to meet their overheads.

Reply to
Dudley
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Think of it as the middle price between the buying and selling price. Banks and building societies often use it to price interest on loans as a couple of % above base rate and interest paid on savings as a couple of % below base rate.

In theory, as the base rate changes, other rates should change too.

I think the Bank of England puts money where its mouth is by offering to lend or borrow at rates close to the base rate. In theory again, supply and demand for lending and borrowing can influence the rate.

The base rate has a direct affect on prices for gilts. The yield for gilts will always be close to the base rate.

Reply to
David

If you look at the yields on the latest offerings by the Debt Management Office, that does not seem to apply. 5% 2014 stock at £110, or 4.55% running yield.

I have a feeling that gilts may affect base rate, rather than vice versa.

Reply to
Terry Harper

There is something known as the "money market" where banks lend each other money on a short-term basis (overnight up to a few months), and where the government also borrows short-term. The BoE intervenes in that market, effectively by offering to lend at a particular rate (actually it offers to repurchase the short-term government bills at a certain price, but it comes to the same thing). Other money market lenders obviously have to follow that or they will become uncompetitive, and that has a knock-on effect on other lending. How much that affects rates at a consumer level varies with different products, depending the source of funding and the competitiveness of the market. For example, credit card rates have almost no connection, but mortgage rates tend to follow fairly closely.

The connection with gilt yields depends on how long the gilt has until redemption. A gilt with only six months to go will follow the base rate almost exactly, a 30-year gilt is affected rather little.

Reply to
Stephen Burke

Neither is dependent on the other. Base rates are for short term variable rate borrowing between banks and the Bank of E. Gilts are long term fixed rate government borrowings.

Reply to
No Flipping

In message , No Flipping writes

Thats the current rate for 11 year money, whereas base rate is akin to three month money.

BoE Base rate should be closely mimicked by the redemption yield obtained from 3 month treasury bonds. These days, with the BoE charged to use Base rate to control inflation (although this last time it seems to have been used also to control the exchange rate), then 3 month bond yields will tend to reflect base rate, although some times the yields can also predict a base rate change if the market is confident of that change.

Longer dated bonds are no guide at all.

Reply to
john boyle

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