Interest rate fallacy?

Milarky

It's just occurred to me that when interest rates go up or down in line with the Bank of England rate (say) they invariably go up/down across all accounts by the same amount (e.g. 0.25%) and that's considered a 'good' thing by all and sundry.

Now what if you already have a very low rate? So low, in fact, that's it's already less than 0.25% (pa)? It can't be cut even by this amount as negative rates would result.

So when rates are really low they can't move in step can they? But should all rate movements be scaled in proportion to whether they started higher or lower than the datum provided by the the BOE?

In other words, if the BOE rate is 5.5% this month and is cut to 5.25% next then a rate of 2.2% should only be cut to 2.1% (not 1.95%) - and a rate of 7.5% should be cut to abou) 7.3% (not 7.25%)

Well, you say, no bank would do that because the average person isn't going to appreciate the distinction between compound (geometric) interest rates and 'simple' (arithmetic) interest. The banks actually do us a 'service' when cutting '1%' to '0.75%' at a stroke - they are just trying to avoid confusion. [fair point]

globalds

The Japanese had Zero percent for a few years ...

I think you perhaps are looking at things the wrong way around .
This would be like saying if the price of fuel was to fall then all petrol providers would have to drop prices by an equal percentage .
The retailer ,just like the bank sets the price of the product they sell ..Interest is just the price .If they feel they can find customers who will pay(or deem the risk to high) then they may even raise the price of the money they lend even if the price they pay for it is cheaper.
It is the free market that will be the final arbiter of each individual banks decision .
I can't see any other way ..If your idea really has any merit ,then the free market will not only give the opportunity for a bank to implement this ,but also test it against competing ideas .

Paul_Herring

IMHO, your original premise is wrong. Bank rates (mortgage or savings) don't have a direct relationship with the BOE base rate.

The more reliable rate is the LIBOR rate. i.e. what it costs the banks to borrow off one another. If that rate goes up, then they increase the savings rates (to still below LIBOR) to get money in so they don't have to borrow off other banks. The other alternative is to increase mortgage rates.

The only reason people equate BOE rate -> savings/mortgage rate is that historically LIBOR has mirroed BOE rate. It's simplistic, and it used to work.

Witness the behaviour during the recent/current credit crunch.

purch

(mortgage or savings) don't have a direct relationship with the BOE base rate.

Thats the common misconception, not helped by the usual inaccuarate and misinformed reporting by our 'bizness' media

The BOE Base Rate only impacts the actions and operations of the Bank in the marketplace

The term LIBOR too, is also often used incorrectly. LIBOR itself, is a reference rate, set by the BBA as an average of the rates supplied by it's panel of Banks. It is not the rate Banks necessarily lend to each other at, because it is an average of a set of reference rates which are impacted and influenced by individual Banks positions.