Download 25 The impact of interest rates

The Impact of Interest Rates
Unit 25
Key Terms
 Interest Rates – the percentage reward or payment over a
period of time that is give to savers or paid by borrowers on
savings or loans.
 Bank Of England – the central bank for the UK. Its role is to
monitor the banking system and to be a banker to the banks.
It is responsible for setting interest rates in the UK.
 Variable Interest Rate – an interest rate that can change over
the period of the lifetime of the loan depending on what is
happening to other interest rates in the economy.
 Fixed Interest Rate – interest rate that stays the same over an
agreed period of a loan.
Credit
 Credit is simply the term given to the ways that a business
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can borrow money.
Businesses need to borrow money for different reasons:It may have long term loans to help pay for equipment (loans
taken out over a period of longer than 1 year),
Or the business may run an overdraft, this allows the business
to use money that it does not have at the time.
It is good business practice for a small business to use loans to
buy equipment and finance longer-term expansion.
Overdrafts should be used to cover short term changes in
cashflow and sudden unexpected bills
The Cost Of Borrowing
 Banks charge interest on the money they lend out. Interest is
the price that has to be paid to borrow money and interest
rates show the money that has to be paid back. For example if
a bank charges 10% interest a year to borrow money on an
overdraft, this means that if you borrow £1,000 then you
have to pay back an extra £100.
 Since many businesses have loans and overdrafts the rate of
and amount of interest is an important consideration.
Interest Rates
 Interest rates can change.
 For borrowers the higher the rate of interest the higher the
amount that has to be paid back, equally, if the interest rates
fall then the business has less interest to pay.
 Rises in the interest rates mean more to pay for loans, and as
a result the total costs of a business will increase leading to
less profit.
 Falls in interest rates mean less to pay for loans, and as a
result the total costs will fall, leading to more profit.
Variable Rates of Interest
 The interest rate on bank overdrafts usually changes over the
year. This means that those interest rates are variable rates.
Bank overdraft rates tend to be set by the Bank of England. It
uses changes in interest rates to control inflation – the rate of
changes in prices in the economy.
 With variable interest rates it is difficult for businesses to
predict exactly the cost of borrowing.
 Large variations mean bigger costs, smaller ones mean
smaller costs.
Fixed rates of Interest
 The interest rates on loans may vary too, however, many
loans to small businesses carry fixed interest rates. This
means that the rate of interest on a loan does not change
whilst the loan is being repaid. If the rate of interest were
8% on a loan for 2 years, then it would stay at 8% and not
change.
 This makes it easier to predict the cost of borrowing and the
costs of the business.
The Bank Of England
 The interest rate that a business has to pay is affected by the
interest rate set by the Bank Of England. The Bank of
England is called a central bank. It acts as a banker to all the
banks. It has a committee called the Monetary Policy
Committee (MPO) that set the interest rates it will charge to
lend money to other banks. This interest rate affects interest
rates through the banking system. If the Bank of England
increases interest rates then the other banks will do the same.
If it reduces the interest rates then the banks usually do the
same.
Interest rates and consumer spending
 Consumers are people (not businesses).
 Consumers, like businesses borrow money for different
things, may be a house, a new car, a holiday or new furniture.
At Christmas consumers may use overdrafts, or credit cards
to pay for presents. When interest rates go up, this makes the
cost of borrowing more expensive and so consumers will be
put off spending or not have as much ‘spare’ money to spend.
If consumers are put off spending this means that business do
not sell their products and so they have less money. Firms
that sell products that of highly priced or seen as luxury
items can really struggle if interest rates are high.
As a Side Point....
 What is happening in the economy at the moment?
 Boom or Bust? Spending or Saving? Government? Recession?
Down turn? Redundancy or Employment?
 Before the SUMMARY – use the cards and match up the
statements.
Interest rates go up
Interest rates fall
..so..
businesses have to pay more
interest on their loans
businesses have to pay less
interest on their loans
..so..
Businesses decide not to
invest in new machines
Businesses decide to
invest in new machines
..so..
Households decide to save
more and spend less
Households decide to save
less and spend more
..so..
Spending in the economy
falls. Some businesses fail
Spending in the economy
rises. Some businesses
expand.
Households are more
keen to borrow money
Households are put off
borrowing money
…and..
…and..
Households have to pay more Households have to pay less
on their mortgage and have
on their mortgage and have …and..
less to spend on luxuries
more to spend on luxuries
Homework
 Unit 25 - Homework
Kagan tasks.