BoE Base Rate

cjn_2

Not being an economist, something that's always intrigued me. The BoE has just cut the interest base rate to 4.50%, but what does this figure actually correspond to? Also, why do rates only ever move by 0.25% - at times when a decision is marginal, wouldn't a smaller move possibly be better for the economy?

grumbler

How Monetary Policy Works :

...The Bank of England sets an interest rate at which it lends to financial institutions. This interest rate then affects the whole range of interest rates set by commercial banks, building societies and other institutions for their own savers and borrowers. It also tends to affect the price of financial assets, such as bonds and shares, and the exchange rate, which affect consumer and business demand in a variety of ways. Lowering or raising interest rates affects spending in the economy....

I am not sure, but I think BOE lends money not to all financial institutions, but only to special ones.

0.25% is quite a small change if compared to about 5%, although it is more significant if compared to 1-2%.

Walletwatch

Correct me if I am wrong, but isn't the BoE, like any other central bank, the 'lender of the last resort' for the banking system? This effectively means that if banks were ever in need of money, the BoE would lend it to them at a rate benchmarked against the BoE rate. Of course, as grumbler's text says, the macro-economic effects of the BoE rate changes are much more far reaching.

Why these rates are in multiples of 0.25%? Well I am not sure, but I think the answer lies in the norms used in money markets while quoting rates of bonds and other instruments (which are typically in fractions of 1/2, 1/4 etc)

grumbler

Walletwatch wrote:

...isn't the BoE, like any other central bank, the 'lender of the last resort' for the banking system? This effectively means that if banks were ever in need of money, the BoE would lend it to them at a rate benchmarked against the BoE rate. ..

Just a couple of new quotes:
http://www.moneyextra.com/dictionary/base-rate-003889.html:

The base rate, sometimes referred to as the repo rate is the minimum rate at which banks are prepared to lend money - it acts asthe benchmark for other interest rates, including personal loans and mortgages.
The high street banks' base rate changes following the Bank of England's signals through its daily money market operations.

The central bank moves base rates by changing the dealing rates at which it buys bills from the discount houses.

http://www.landlordzone.co.uk/bank_rate.htm:

The Bank Base Rate is the rate currently referred to as the Bank of England's UK Repo Rate. It has been variously referred to as: Bank Rate, Minimum Lending Rate, Minimum Band 1 Dealing Rate, and Dealing Rate.

I have no idea what all this mean, but would be interested to know. Any comments are welcome

Walletwatch

One thing I know is that as part of the regulatory norms laid down by the Central bank of any country, banks are required to retain a percentage of their deposits as liquid cash reserves or invested in gilt securities. A snapshot of the bank's balance sheet is taken periodically (every fortnight for instance), and at that point, the bank's total deposits are reported, along with the cash reserves held with the bank as of that point. If just before the reporting date, any bank were to fall short of the reserve requirement, they would go to the market and borrow this money from other banks (which are surplus in funds, i.e. have more cash than their total deposits would require)as an overnight deposit, so as to satisfy the reserve requirements.

Guess this rate is tied to the BoE rate as well, from what your quote says?

cjn_2

Thanks for all the answers - I did have a look at the BoE site but wasn't any the wiser, still not particularly but there you go!

cloud_dog

cjn

Lets get the easy one out of the way first; BoE rate rises can be implemented in any size, i.e. 0.25, 0.5, 0.75, etc. I think the 0.25 multiples are just because it breaks the 1 point neatly into four (just my guess). If you look back at rate cuts / rises there have been occasions when they increased / decreased by 0.5%. I think a general rule of thumb (this being my thumb of course) is that the larger the an individual increase/cut is implies more of a panic situation to either depress or stimulate the economy. Looking back to 'Black Wednesday' we saw a rate rise of 2% on one day, swiftly reversed when we exited the ERM.

Regarding what the Boe rate represents. I think you can break this down into to two aspects. The first has already been mentioned in posts, i.e. it is a reference point for the commercial banking community. The second aspect is that the rate itself does not 'mean' anything; it is a device who's level affects aspects of the economic world for the UK. As a very basic description it allows the BoE to take money out of the economy (restricting growth) or by allowing the addition of money into the economy (stimulating growth), i.e. lower mortgage repayments means householders have more disposable income to spend on the economy.