Interest rates are changing: How does it affect mortgage borrowers?

The Bank of England is road testing a new way of setting interest rates that could have a massive impact on mortgage borrowers in the next few years.

With Bank base rate at rock bottom 0.5% for more than six years we have all forgotten the days when the monthly rate setting was a moment of suspense.

Not since March 2009 has the base rate moved and the monetary policy committee – the 12 person rate setting body that is part of the Bank – has simply rubber stamped the status quo.

There have been some dissenters but the current methods needs a majority to shift the interest rate.

How does it work?

Since 1999 the Bank of England has had the power to set interest rates independent of Government through the MPC.

It has to adjust rates in relation to a 2% inflation target as set by Gordon Brown’s Treasury in the late 1990s.

During the financial crisis, central banks decided to cut rates in order to boost national economies with little thought for inflation.

UK inflation hit 5.2% in 2012 and yet the Bank was rock solid on keeping rates at 0.5% with few dissenters. Then Bank governor Mervyn King insisted inflation was temporarily driven up by external factors such as foreign oil price and other commodities.

This led to a clamour for change in how the Bank should operate and Chancellor George Osborne agre3ed to review how it sets rates under Governor Mark Carney, who took the top job in August 2013.

How will it work?

Now the results are in. The Bank will trial a new systems in June and July and fully launch in August.

The new schedule for running interest rate meetings will start almost a week earlier than has been previously.

This will boost transparency by allowing minutes of the meetings to be drafted ahead of the vote. The minutes will then be approved before they are made public, typically on the first Thursday of the month.

There will also be a pre-MPC meeting to take account of more economic data and minutes published more quickly.

The new method will take into account growth as well as inflation meaning it is more difficult to estimate when rates will rise.

What does it mean for borrowers?

In theory this new method should add greater depth to interest rate setting discussions and allow journalists, economists or members of the public to better scrutinise how they reach a verdict.

For mortgage borrowers it will mean little for the time being. But when rates start to rise – and they will – then these changes will become significant.

For example, inflation is at -0.1% today but growth is still strong so the Bank must balance an interest rate decision against both factors.

It is more dynamic system than previously and borrowers should expect to see more steady rises and more splits in the committee.

It is expected to make for more steady policy making and gradual increases in rates over the next few years rather than a few sudden jerks.