How interest rates work in the UK

Learn how interest rates work in the UK, who sets them and how they affect mortgages, savings, borrowing, inflation and financial planning.
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Interest rates are the percentage charged on borrowing or paid on savings, set periodically by the Bank of England through its Monetary Policy Committee (MPC). 

This benchmark, called base rate (also called bank rate), influences borrowing costs, savings returns, inflation and confidence across the economy. When it rises, borrowing typically becomes more expensive and savings returns improve; when it falls, the reverse happens.

This guide will explore how interest rates work and how to prepare for effective property investment.

Key takeaways:

  • Interest rates determine what borrowers pay and savers earn.
  • The MPC sets base rate eight times a year.
  • Base rate changes can affect mortgages, savings, cash ISAs, notice accounts and borrowing costs.
  • Rates interact with inflation, growth and markets, while higher rates dampen demand, with cuts supporting economic activity.
  • Affluent borrowers should factor in tax efficiency and succession planning.

What are interest rates?

An interest rate is the percentage a lender charges for providing capital or the percentage a bank pays for holding deposits. For example, a 3% rate on a £1m development facility means £30,000 of gross annual interest, while the same rate on a notice account adds £30,000 to capital (before tax).

Rates differ across products as lenders factor in risk premiums, funding costs and term length. This produces rates for mortgages (including offset mortgages), loan APRs and bond coupons which borrowers see on a regular basis.

Here’s how interest rates typically affect fixed-rate and variable-rate products:

  • Feature:
    How it works
    Fixed interest rate:
    Stays the same for an agreed period, irrespective of a base rate change.
    Variable interest rate:
    Rises or falls over time, often in step with a lender’s standard variable rate (SVR) or the base rate.
  • Feature:
    Advantages
    Fixed interest rate:
    Predictable monthly repayments make budgeting easier and protect you if higher rates emerge.
    Variable interest rate:
    Beneficial if rates fall, offering greater flexibility for early repayment or term changes.
  • Feature:
    Considerations
    Fixed interest rate:
    No benefit if market rates drop during the term, with early-repayment charges possibly applying.
    Variable interest rate:
    Payments or returns can change, making budgets less predictable, along with higher rates increasing borrowing costs.
  • Feature:
    Typical products
    Fixed interest rate:
    Fixed-rate mortgages, fixed-rate personal loans, fixed-term savings accounts and fixed-rate bonds.
    Variable interest rate:
    Variable-rate mortgages, tracker mortgages, lenders’ SVR loans, easy-access savings accounts as well as some business loans and overdrafts.

Who sets these rates?

The Bank of England sets the base rate, forming the anchor from which UK interest rates take their cue.

The UK government tasks the Bank of England with keeping inflation at a target of 2% in the medium term, with interest rate setting being the key tool at its disposal. That decision rapidly influences lenders’ funding costs, the price of mortgage rates and the savings rates available on cash deposits and bonds for property financing purposes and more.

Each commercial lender typically bases its funding spreads, regulatory costs and competitive strategy on bank rate. Conversely, local bank managers may price products around individual circumstances. This can be a significant advantage for investors with specific borrowing structures or wealth-management needs.

Why do interest rates change?

Interest rates track the pulse of economic growth, energy prices, employment trends and wider financial markets sentiment. 

During periods of strong demand and rising prices, policymakers generally set higher rates to contain UK inflation. In downturns, they often favour a base rate change that supports lending and liquidity.

In recent years, base rate has seen a rapid shift from 0.10% in 2021 to 5.25% in 2023, and down to 3.75% by late 2025, illustrating how monetary policy can pivot when economic conditions evolve. 

Link between interest rates and inflation

When considering the impact of inflation on interest rates, higher borrowing costs can mean households and businesses must allocate more cash to debt repayments and less to new spending, which can significantly ease upward pressure on prices. Conversely, lower rates reduce debt-servicing costs and encourage investment, which can reignite demand and lift inflation.

The rate of inflation Opens in a new window is the change in prices for goods and services over time and a metric that informs advanced planning for tax efficiency and wealth preservation. 

What impact do interest rates have on mortgages, savings, borrowing and the wider economy?

When bank rate rises, lenders usually pass this on through higher borrowing costs and improved savings rates. Business borrowers feel it too, as rising rates raise the cost of credit and finance, potentially delaying expansion.

Practical interest rate planning considerations for saving and borrowing

There are a few ways to mitigate interest rate changes. 

Mortgages:

Stress-testing monthly loan repayments against higher rates, particularly with large facilities or multiple properties. It is a good idea to model what might happen in different scenarios, something we encourage borrowers to consider.

Aligning mortgage terms with your cash-flow forecasts. For instance, a two-year fix may suit an expected rate change, whereas a five-year fix may offer longer-term certainty.

Evaluating hedging tools such as interest-rate caps or swaps for predictable repayments.

Savings:

Optimising liquidity across current accounts, savings accounts, easy-access cash, notice deposit accounts and fixed-term bonds to capture higher savings rates while staying flexible.

Gaining property insights and more from a trusted expert can help investors make thoughtful decisions in response to interest rate changes.

Get guidance on property investment, mortgages and interest rates from Handelsbanken

Interest rates, set by the Bank of England's Monetary Policy Committee (MPC), shape the UK's mortgage costs, savings returns, inflation and economic activity, leading to different risks for fixed and variable products.

Handelsbanken's relationship-led approach helps customers navigate rate volatility with confidence. We combine local decision-makers with sector insight, integrating property financing, wealth management, sustainable investing, and portfolio bonds into one cohesive plan built on trust and a long-term partnership.

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FAQs

  • What are interest rates in the UK?

    Interest rates are the cost of borrowing and the reward for saving. The Bank of England sets bank rate to anchor the wider market for mortgage rates, savings rates and corporate lending.

  • How do UK interest rates work?

    Commercial banks set their interest rates by starting with bank rate, then add funding and risk margins and offer products, including fixed-rate mortgages and variable-rate savings accounts. A base rate change subsequently shifts borrowing costs and returns across the UK financial system.

  • Why do interest rates change in the UK?

    The Bank of England's MPC adjusts bank rate to keep UK inflation at or near 2% in the medium term while supporting sustainable economic growth. Energy prices, global events and domestic wage trends all influence the MPC's decisions.

  • How do interest rates affect mortgages, savings and borrowing in the UK?

    Higher rates lift monthly repayments on tracker and variable rate mortgages, improve easy-access and notice savings account rates and can increase costs for personal loans and credit cards. When bank rate falls, the opposite usually happens.

  • Will mortgage rates ever go to 3% again?

    A return to mortgage rates near 3% would require further bank rate cuts and favourable funding  conditions. Instead of chasing a specific number, we recommend tracking the geopolitical situation and making adjustments as needed. Stress-test affordability and weigh the benefits of locking in certainty versus maintaining flexibility with your next investment

    Stay ahead of shifting UK interest rates by subscribing to our monthly Rate Wrap email, gaining expert insights on central bank decisions and what they might mean for your finances.

    Sign-up to the Rate Wrap

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