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What will the Brexit trade deal and coronavirus mean for interest rates?

The Bank of England base rate remains at an historic low

What will the Brexit trade deal and coronavirus mean for interest rates?

A year after its dramatic base rate cut, the Bank of England has today (18 March) announced it’s maintaining the base rate at 0.1%.

The Bank of England’s Monetary Policy Committee (MPC) voted unanimously nine to zero to keep the base rate at its historic low.

In February, the Bank of England gave lenders six months to prepare for negative interest rates, but stressed that this didn’t mean another base rate cut is a certainty.

Here, Which? looks at the impact that coronavirus and Brexit have had on interest rates.


One year since the base rate cut: what has changed?

This week marks one year since the base rate was first set to its historic low of 0.1%.

In theory, this would mean that savings and mortgage rates would have reduced in line with the base rate drop, and then remained static for the past year. But this hasn’t been the case.

In fact, both savers and borrowers have been experiencing the worst of both worlds, with savings freefalling to new lows for several months in a row, and mortgage rates rising rather than falling.

Mortgage rates rise since base rate cuts

The coronavirus outbreak and two cuts to the base rate in quick succession saw lenders withdraw thousands of mortgage deals, with riskier low-deposit mortgages the biggest casualties.

A year on from the second base rate cut, there are 3,939 mortgages on the market – a drop of 31% on the 5,723 recorded last March.

In the wake of the pandemic, banks withdrew nine in 10 90% and 95% mortgages. Although deals have begun to return to the market in recent months, the number of low-deposit mortgages available to first-time buyers remains 66% lower than a year ago.

The average rate on a two-year fix is currently 2.57%, up 0.14% on last year, while five-year fixes have risen by 0.01% to reach 2.75%.

These changes might seem minor on paper, but when we look at the cheapest initial rates available on two-year fixes at different loan-to-value levels, we can see how badly borrowers with small deposits have been affected.

Loan-to-value Best rate (March 2020) Best rate (March 2021) Change
60% 1.14% 1.06% -0.08%
75% 1.24% 1.24% 0%
80% 1.39% 1.81% +0.42%
85% 1.42% 2.39% +0.98%
90% 1.59% 2.99% +1.40%

Source: Data from Moneyfacts, March 2021. Fixed-rate deals available to home buyers only. 65% and 70% mortgages have been omitted as the cheapest deals were available at up to 75% loan-to-value.

Savings rates continue to fall

Average savings rates across the board have fallen to new lows in March, according to data from Moneyfacts.

The average interest offered by an instant-access savings account in March is just 0.16%, with the average cash Isa equivalent paying a little more at 0.23%.

The average rate for one-year fixed-rate savings accounts is now 0.43%, with one-year cash Isas at 0.38%, having fallen by 0.3% and 0.4%, respectively, in the past month alone.

The picture isn’t any better for long-term fixed-rate accounts – that is, those with terms of 18 months or more. Long-term fixed-rate savings accounts offer an average rate of 0.65%, whereas long-term fixed-rate cash Isas offer an average of 0.59% interest.

Compared with April 2020, a couple of weeks after the base rate change, the average rate on both long-term savings accounts and cash Isas have fallen by 49%. One-year savings are down 61%, whereas average rates for one-year fixed-rate cash Isas have dropped by 63%.

But instant-access accounts are the worst off. In just a year, instant-access savings accounts now pay an average rate that’s 69% lower than in April 2020, and for instant-access cash Isas the average rate has fallen by 71%.

While it’s true that rates had been falling for some time before the base rate change, all average rates in April 2020 had fallen by between 19% and 29% since May 2019, showing that the fall in rates has certainly sped up in the past year.

What’s happened to savings after past base rate changes?

The graph below shows how average rates have fared over the past five years for instant-access savings accounts and cash Isas, one-year fixed-rate savings accounts and cash Isas, and long-term fixed-rate savings accounts and cash Isas using data from Moneyfacts.

The rates fall becomes visibly more dramatic following the base rate cut in March 2020, but, looking back, past base rate changes have not had such a profound effect on savings rates.

For instance, in August 2018 the base rate was increased from 0.5% to 0.75%. A small rate uplift can be seen around September 2018, which then flattened out and began to fall around mid-2019 – despite the base rate remaining the same.

The pattern between the base rate and average savings rates follows more closely the further back you look. For instance, it follows that average rates fell around September 2016 when the base rate was reduced from 0.5% to 0.25%, and subsequently rose from November 2017 when it went back to 0.5% again.

This suggests that factors other than the base rate – be it coronavirus and/or Brexit – have been having a bigger impact on savings rates than the base rate in recent years.

Will interest rates turn negative?

The Bank of England said in June 2020 that it was considering introducing a negative interest rate to help boost the UK economy in the future. In October, the Bank of England sent a letter to lenders asking them how ready they would be for a zero or negative interest rate, reaffirming the possibility of such a move.

In February, the Bank of England said high street lenders should be ready for negative interest rates in July, just in case they’re needed. However, if the success of the vaccination program leads to an economic boom before then, it might keep rates above zero.

If a negative base rate were to be introduced, it would be the first time the rate had dropped below zero in the country’s history and it would have wide-ranging effects. Potentially, it could even mean you’d have to pay your bank to hold your cash.

Savings rates, already in decline, have fallen steeply since the base rate was reduced to 0.1% in March. Negative interest rates could make high-return savings accounts even harder to come by.

On the flipside, borrowing could become cheaper, which would be good news for people with mortgages.

Why are interest rates so low?

The pandemic’s spread in March 2020 caused the Bank of England to make two major cuts to its base rate in rapid succession.

On 11 March 2020, it cut the rate from 0.75% to 0.25% – a record low at the time. Just eight days later, the Bank slashed it even further to 0.1%, where it remains today.

Decisions about the base rate are usually made during scheduled MPC meetings. But March 2020’s two cuts were made at emergency meetings called in pandemic’s wake. These were the first emergency MPC meetings since the 2008 financial crisis.

The MPC changes the base rate with the intention that this will help ‘sustain growth and employment’. However, the pandemic continues to hamper both.

The most recent unemployment data shows that from October to December 5.1% or 1.74 million people were unemployed, according to the Office for National Statistics (ONS). This is the highest figure in five years.

The furlough scheme has helped protect jobs, but the Office for Budget Responsibility expects 2.2 million people to be unemployed at the end of the year, or 6.5% of all workers.

The UK officially entered a recession in August 2020, with Gross Domestic Product (GDP) plummeting to its lowest level on record.

This alone would be enough uncertainty for the Bank of England to deal with. But as the minutes of recent MPC meetings note, Brexit is also a concern.

How Brexit influenced interest rates

The Bank of England’s two emergency cuts in March 2020 were unrelated to Brexit, although speculation around exiting the European Union has had an impact on the base rate in the past.

The Bank of England slashed the interest rate in half – from 0.5% to 0.25% just after the referendum on EU membership in 2016, although it did eventually raise it above pre-referendum levels two years later.

The MPC tended to work on the assumption that a trade deal would be agreed between the EU and the UK before the end of the transition period in January 2021. While that may have appeared overly optimistic during fraught trade talks, eventually it proved correct.

Now that the transition period is over and a new trade deal has been agreed, Brexit might be a smaller influence on the MPC’s thinking. That said, the minutes of the committee’s February meeting note that some firms it has spoken to still cite Brexit as one of their top three concerns.

Why the base rate matters

The Bank of England base rate influences how much banks and other lenders charge customers to borrow money, and the amount of interest they pay on savings.

A lower base rate generally means lower interest on savings, so your pot will grow a little more slowly. But mortgage and loan interest rates are likely to drop, too, making it cheaper to borrow.

A higher base rate usually means that savings interest grows faster, but mortgages and loans become more expensive.

The chart below has the base rate and the average standard variable mortgage rate since October 2016, for comparison.

The Bank of England changes the rate to help keep inflation at around 2%, which is considered a sustainable level, raising and lowering it in line with current events. It kept the rate the same for years after the 2008 crash, but Brexit – and now the pandemic – have forced the Bank of England to make quick and dramatic changes.


This article was originally published on 17 September 2020 when the Bank of England announced it was holding the base rate at 0.1% until the next MPC meeting. It was last updated on 18 March 2021 after the Bank of England announced it was holding the base rate at 0.1%. Additional reporting by Stephen Maunder and Danielle Richardson.


 

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