Effectively, interest rates are higher than you might think

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A couple of months ago I asked if high effective interest rates were part of the reason that the Base Rate remains so low.

Today the Bank of England released their data on effective interest rates – the actual cost of borrowing money faced by businesses and households.

It shows that the difference between the Base Rate and the rates paid by business and households has increased notably following the recession – the “credit crunch” phenomenon that choked the economy to begin with.

Figure one: effective interest rates are higher since the recessionAverage difference between the Bank of England base rate and the actual interest rate paid pre- and post- April 2008.

What is striking is that this difference has not dropped back much since recovery began. This is especially true for secured lending to households, but applies to business lending too.

Figure two: effective interest rates remain high relative to the Base RateDifference between the Bank of England base rate and the interest rate paid by business for outstanding loans

So the low Base Rate is not fully reflected in the interest rate paid by businesses and households. This is the hangover from the credit crunch. And it has implications for monetary policy. For one thing, it implies that – all other things equal – a lower Base Rate could be consistent with lower inflation than was the case pre-recession.


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