What do interest rates represent

Even a small change in interest rates can have a big impact. You can borrow money to buy something today and pay for it later. Interest is what you pay for the privilege. It is our job to set this interest rate. We explain why we decide to keep the rate the same or change it in our Monetary Policy Report.

We use Bank Rate in our dealings with other financial institutions, which influence lots of other interest rates in the economy. This includes the various lending and savings rates offered by high street banks and building societies. For loans, other factors are considered, including the risk of the loan not being paid back The greater the bank thinks that risk is, the higher the rate the bank will charge.

It can also depend on how long you want to take out a loan or mortgage for. You can use our interactive chart to see how interest rates of different financial products have changed over time. Hi, my name is Geoff and I work at the Bank of England.

Interest rates were cut sharply in and remain extremely low by historical standards. With rates so low for so long do they really matter anymore? Yes they do. For most, interest payments on a mortgage are one of the biggest outgoings. Covering the cost of spending on credit cards and pay day loans can also be a big drain.

Many of those with savings rely on interest payments from the bank to provide essential income to live on. If interest rates rise, borrowing could become more expensive for you. If the interest rate on the mortgage is 2. Of course, interest rates can go down as well as up. You can use a mortgage calculator Opens in a new window to work out how your monthly payments might be affected. Based on the applicant's credit score, lenders may charge a lower interest rate for borrowers who have high credit scores, and are a better repayment risk or a higher interest rate for borrowers who have lower credit scores and are a larger repayment risk.

Interest rates are something of a sweet science for economists, and for financial institutions who lend money and extend credit. The goal is to issue interest rates in that proverbial sweet spot, where the rate is high enough for lenders to make money but low enough to attract borrowers.

In the case of a bank or bond issuer, the idea is to keep rates low enough to save money, but high enough to attract depositors and investors. Let's take the case of a borrower who wants to buy a home, and is willing to pay interest on a home loan to seal the mortgage deal.

A borrower will pay compound interest on things like mortgage loans and auto loans which are repaid over an agreed-upon time period , and credit cards, too which compound indefinitely, so it's advisable for card users to pay down their card debt quickly. On the savings and investing side of the compound interest equation, investors and savers earn compound interest based on the size of their total investment. Interest rates can influence the economy in multiple ways, but at a base, direct level, the biggest impactors are rising and falling interest rates.

Rising rates. Rising interest rates make the cost of borrowing money and getting credit tougher to obtain. That not only hurts consumers and businesses, who can't get the cash they need to buy a home or hire new employees, but it also hurts financial institutions, too. After all, with rates high and conditions dour on the lending front, that leads to fewer borrowers and fewer revenues and profits for banks, credit card firms, and other financial services companies.

It also means less business for retailers, as customers make fewer purchases on goods like clothes and cars, thus hurting the bottom lines of U.

On the plus side, bank depositors will see better returns in a rising interest rate environment, as will bond investors, who benefit when rates climb. Declining rates. Lower interest rates lead to a multitude of financial problems and benefits for consumers, companies, and financial services firms.

In a lower rate environment, consumers and businesses often slow down savings, and increase their debt levels, as loans and credit are easier to obtain. Weaker rate levels also spell bad news for bank savers and bond investors, and investment returns fall as rates decline. On the plus side, lower interest rates mean more opportunities to buy big-ticket items like homes and autos, which is good for the overall economy.

Plus, stock market investors usually do better as rates decline and the economy improves, as companies make more seals and earn more profits, which are good for their bottom lines, and good for stock prices.

Receive full access to our market insights, commentary, newsletters, breaking news alerts, and more. This is the rate that banks charge to borrow from each other overnight, and it serves as a benchmark that most other rates are set from.

When the federal funds rate goes up, expect to see a proportional rate increase in other variable rate consumer loans. However, nominal interest rates alone do not account for inflation, which is simply the increase in prices of goods and services. When inflation is on the rise, every dollar in your wallet can purchase a little less. And, as you can see in the equation, inflation directly affects the real interest rate. In this scenario, the real interest rate is negative 1 percent.

That means your purchasing power will decrease by 1 percent every year that passes if circumstances remain unchanged. As a result, you might want to move money into riskier assets, such as stocks, to generate a rate of return that beats the inflation rate. In other words, a low or negative real interest rate encourages risk-taking in the economy.

The real interest rate is then 3 percent, which means your purchasing power is rising without taking any risk. In this scenario, it may not be all that compelling to invest in riskier assets.