Copyright 2002 TecEd

Exchange rates


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Interest rates

The “base” interest rate set by the Bank of England is a major factor determining the interest rates charged by banks such as Barclays and Lloyds. How banks and other financial institutions set their borrowing and saving rates is complex, but if the Bank of England’s base rate changes then all of the other interest rates are likely to change.

One point to remember is that you can sometimes borrow money at a fixed rate of interest i.e. you agree from the start that you will pay a certain interest rate. Changes in the the Bank of England’s base rate will have no effect on such loans. However, if the base rate fell then you would probably look for a cheaper loan and pay off your more expensive loan. The “world of finance” is complicated - that’s why you can earn a good salary as a financial advisor! - but all you need to concern yourself with here is the effect of a change in interest rates on business performance.

If interest rates increase then businesses could be affected in the following ways:

  • If they have borrowed money, then the cost of repayments could increase
  • If they are thinking of borrowing money, then it will be more expensive to do so
  • The money they get back from any savings they have deposited in banks may well increase
  • Private investors could receive more return by placing money in a savings account

Task

  1. Describe the possible effects of a fall in interest rates on a business (E6)
  2. A Public Limited Company has made profits (after corporation tax) of £3.4 million. The directors of the company are currently deciding how much of this profit to distribute to shareholders and how much to invest back into the business. The company has an expansion plan which will require an investment in machinery and buildings of £5 million. The Bank of England recently increased the base rate of interest from 4% to 5%.

    Evaluate the effects of the Bank’s change in the base rate of interest on the company (A3)