When it comes to interest rate, why is the base rate important?

The main task of any central bank is to provide a framework for the economy to grow sustainably


Interest is the cost of borrowing money or the reward for saving. It is measured by a percentage, or rate.
The most important interest rate – one that affects the whole economy – is set by a country’s central bank. It is called the base rate.
Central banks lend money to commercial banks, who in turn lend to businesses and individuals. Of course, they charge interest on those loans.
The theory – and the hope – is that these loans lead to more spending and investment and a healthy economy.
When a central bank cuts its base rate, it becomes less attractive to save.

On the other hand, businesses are more likely to borrow money to invest in new machinery, or take on more staff. People feel more confident about taking out a mortgage on a new home, or buying a new car.
To boost a sluggish economy a central bank may even introduce a negative interest rate to try to get lenders to invest in the real economy rather than hoard cash.
But let’s not forget that the main task of any central bank is to provide a framework for the economy to grow sustainably, by targeting a steady currency and low inflation.

So if – for example – prices are rising too fast, the central bank may want to intervene to cool the economy by pushing interest rates up.
This would encourage people to save – they would tend to spend less on consumer goods.
Companies may think twice about splashing out on new equipment, and retailers might cut prices to encourage trade. This in turn can calm inflation.
However, people with – say – a mortgage on a house would suffer – their monthly repayments would increase.
So – high or low – interest rates have an impact on all of us!

Sources: Bank of England, Federal Reserve, European Central Bank

This report was produced by Mwanzo TV with the support of Code for Africa and Deutsche Welle Akademie Kenya

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