The base rate - What is its role and how does it affect you?

The role of the base rate

One of the central bank’s goals is price stability, and one of their tools for maintaining this is the base rate and changing it.

What is the base rate?

The base rate is a key interest rate that the central bank accounts for in the direction of commercial banks.

Commercial banks (ie all banks where you can open an account) are required to deposit a pre-determined amount at the central bank, at which point the central bank pays interest.
This is true not only on the deposit side, but the central bank base rate also affects the interest rate on loans that commercial banks take out from the central bank.

How does the base rate affect the economy?

The more an economy spins, the higher the level of inflation creeps in, this is a legitimate process. The slower the processes, the greater the risk of facing deflation. The task of the central bank is to ensure balance and price stability in the economy by maintaining inflation targets. And one of the most obvious ways to do this is to regulate how much money can be spent.

By changing the base rate, the central bank can indirectly regulate the amount of money in the economy.

If the economy is slow, they will cut the base rate. You can also see this in the picture for the 2013 section. At that time, the effects of the 2008-2012 crisis still had to be recovered, and a resumption as soon as possible was needed. And this was achieved with very frequent (it was monthly) interest rate cuts.
Lending rates have become lower, borrowing has become easier, and more money has entered the economy. This was obviously not there for self-interest, but was also spent by businesses and individuals. By spending it (so they bought either a product or a service), they helped spin it all up again.

This picture above is just a presentation of the Hungarian base rate levels, but the principle works the same everywhere.

However, the current situation poses a risk of too high inflation, partly due to the restart due to covidity and high expected consumption, so it is necessary to cool the system as a preventive step. By raising the base rate (even as well as a little), it will be harder to borrow and thus reduce the amount of money in the economy. This will somewhat dampen consumption, including inflation.

How does a change in the base rate affect you?

Changes in the base rate also indirectly affect your life. Now, we’re not going to go into how the level of inflation affects you, that’s what was already mentioned in the post about inflation. Now let’s take a direct look at how the central bank affects your investments and loans.

In the case of investments

As to what is the difference between saving and investing, you may have previously found an article on the site, now let’s look at the impact on them.

With the change in the central bank base rate, everything else will change. A change in the central bank base rate can affect your investment in several ways.

Savings levels are rising

Because it is somewhat more difficult to take out a loan (either as an individual or as a business), the income that is already generated is not spent to the extent that people build the credit itself. As a result, the level of savings will increase somewhat. (How much this will happen now, after covid shutdowns, is not yet known.)

Through the level of investment

Since a company can only get a loan at a higher price, they can also choose not to make an investment now or not at all. In doing so, they say no to a later production as well.

If you have a company that goes that way, obviously your subsequent production performance will not increase, nor will your revenue. Then the value of the company does not increase (possibly decrease significantly).

The same is true when you invest in the shares of a company that decided to do so. After all, people love growth, and such a move could discourage investors from temporarily stopping the stock price from rising or possibly falling. Lack of investment can also have a bad effect on their ability to pay dividends, which is also not good news if you have one such paper.

However, the current level of investment typically does not affect bond yields.

Return on investments

For investments, return and risk go hand in hand. You expect (and at best get) the extra return because you have taken the extra risk.

However, with the increase in the base rate, the risk-free return also increased. As the risk level of a given investment asset has not yet changed, many investors expect to receive an extra return for the extra risk they still take. This, in turn, can or cannot be made by the device. If not, it can be expected its owners to look a place for their money elsewhere. If this phenomenon is massive, the level of investment is expected to decline.

In the case of loans

As the central bank base rate changes, so does how cheap or expensive a bank can raise money to give you a loan. Obviously, he does not manage this himself, but priced it into the interest on the loans. This will also change the interest rate on new loans.

Which loan is affected by the change in the base rate?

For floating rate loans

When you signed your contract, you also signed the interest period you would like to choose, so you can find the relevant information in your contract and the lending bank also will help you.

A floating interest rate set for a short interest period is typically cheaper than a longer or fully fixed one, but the downside is that the bank watches the change in BUBOR (or other reference interest) more often, and thus the repayment of your loan may change more often.

In the case of forint loans, floating-rate loans are usually priced to the level of BUBOR, which in turn is directly related to the base rate. Thus, a change in the base rate means for you that at the end of the interest period, the bank will recalculate the installment of your loan and it may raise some of it.

You can calculate the effect of the interest rate change on your own loan with the calculators on the Silver Moon’s site.

If you are still far from the end of the interest period (eg it will only be due in a few years), the bank will not do anything at the moment, but will recalculate the interest at the time of the actual round.

For fixed rate loans

With fixed-rate loans, it doesn’t matter if you have a home loan, a free-use loan, or whatever, you won’t be affected by a change in the base rate at all, neither now nor later.

For other loans

Credit cards, overdrafts, and other credit products are usually renewed annually (unless your contract specifically provides otherwise). This means to you that although there is no noticeable effect of the change now, it will be expected with the anniversary, as you can expect to get more expensive in the next 1 year.

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