Interest rates

An interest rate is the price paid for borrowing money and the reward received for saving. It is charged as a percentage, so 5% interest on a £20,000 loan costs £1,000 a year on top of repaying the money borrowed.

Rising interest rates

When rates go up, borrowing costs more. A business repaying a loan or overdraft hands over more interest each month, leaving less cash for everything else. Investment is often the first thing to suffer: new equipment, extra premises or a bigger delivery van may be postponed because the project now has to earn enough to cover dearer finance. For example, a garden centre borrowing £60,000 to build a café would pay £2,400 a year in interest at 4%, but £4,200 at 7% — an extra £1,800 that might persuade the owners to wait.

Customers are affected too. Higher repayments on mortgages, car finance and credit cards leave households with less disposable income, so they spend less, especially on non-essential goods and services. Lower demand means lower sales and possibly lower profit for the businesses selling to them.

Falling interest rates

Cheaper borrowing works the other way. Businesses are more willing to fund investment, and consumers may take out loans and spend more, which can raise demand. Falling rates are not automatically good news for everyone, though: savers earn less interest, so customers living on savings income may cut back.

Why the effect varies

A rise in rates can even help a business whose customers are savers with money in the bank, because they receive more interest and may have more to spend. The overall impact depends on how much the business itself borrows, how much its customers borrow, and whether those customers are mainly savers or borrowers.