An interest rate is the price of borrowing money or the return earned for saving it, usually expressed as a percentage per year.
If you borrow money, interest is what the lender charges you. If you deposit money with a bank, interest is what the bank pays for using your funds.
However, there is no single interest rate. Central banks set important policy rates, financial markets influence wholesale rates, and commercial lenders set their own mortgage, loan and savings rates. The rate offered to a particular customer may also reflect risk, loan length, security, fees and competition.
Suppose you deposit £10,000 in a savings account paying 5% annual interest.
Ignoring tax, fees and compounding during the year:
£10,000 × 5% = £500
After one year, you would have earned £500, leaving a total balance of £10,500.
Now reverse the transaction. If you borrowed £10,000 at a simple annual interest rate of 5%, £500 would represent one year’s interest on the original balance.
The percentage is the same, but the direction of payment changes: the saver receives interest; the borrower pays it.
Real financial products are usually more complicated. Loan balances may fall as repayments are made, savings interest may compound, rates may change and fees may apply. Measures such as APR and AER can therefore tell you more than a basic nominal rate.
The following example shows simple interest on £10,000 over one year:
| Annual interest rate | Interest on £10,000 | Balance after one year |
|---|---|---|
| 1% | £100 | £10,100 |
| 2% | £200 | £10,200 |
| 4% | £400 | £10,400 |
| 6% | £600 | £10,600 |
| 8% | £800 | £10,800 |
This simplified calculation assumes that the balance remains unchanged and excludes tax and fees.
For borrowers, the interest charged on a conventional repayment loan will not normally equal the original balance multiplied by the annual rate because the outstanding balance reduces as repayments are made.
Compound interest means that interest is calculated on the original sum and on interest previously added to it.
If £10,000 earned 5% annually, with the interest added to the account once a year and no withdrawals, tax or fees, it would grow approximately as follows:
| Time | Approximate balance |
|---|---|
| 1 year | £10,500 |
| 5 years | £12,763 |
| 10 years | £16,289 |
| 20 years | £26,533 |
| 30 years | £43,219 |
During the first year, the account earns £500. During the second year, the 5% return applies to £10,500 rather than only the original £10,000.
Compound interest can help savings and investments grow, but the same mathematical effect can work against borrowers when unpaid interest is added to a debt.
The basic annual compounding formula is:
Future value = Principal × (1 + interest rate)ᵗ
Here, t is the number of years. The calculation must be adjusted if interest compounds monthly, daily or at another frequency.
A central bank’s policy rate is not the rate that every consumer or business receives.
Instead, it acts as an important reference point for the wider financial system. A lender setting a mortgage, credit card or business-loan rate may consider:
The institutions providing credit also operate within different regulatory and licensing structures. Recent examples include Wise’s OCC bank-charter rejection and the GENIUS Act and Revolut’s pursuit of a French banking licence through the ACPR and ECB framework. These issues do not determine an individual interest rate, but they form part of the wider structure within which financial institutions take deposits, lend and compete.
Consequently, two people borrowing the same amount may be offered different rates, while different financial products from the same lender may carry very different rates.
Central banks use policy interest rates to influence monetary and financial conditions. The precise mechanism varies between economies.
The Bank of England’s Bank Rate, sometimes called the base rate, is the UK’s principal policy interest rate. Changes in Bank Rate influence the rates banks and building societies charge borrowers and offer savers, although the relationship is not automatic or identical across products.
The Bank of England explains that Bank Rate affects spending and inflation through its influence on borrowing and saving decisions.
Interest-rate policy is only one part of a central bank’s work. The Bank also monitors risks elsewhere in the financial system, including international exposures; Finance Gazette has separately examined the Bank of England’s review of UK financial exposure to Asian AI and semiconductor companies.
In the US, the Federal Open Market Committee sets a target range for the federal funds rate. This is the rate at which banks and other depository institutions lend reserve balances to one another overnight.
The Federal Reserve uses administered rates and other tools to keep the effective federal funds rate within its target range. Changes then influence other short-term rates and broader financial conditions, as outlined by the Federal Reserve.
The European Central Bank sets three key rates for the euro area:
Together, these help the ECB implement monetary policy and influence euro-area financing conditions. The ECB publishes its latest decisions and rates through its monetary-policy section.
The rate itself is only part of the story. Changes in oil prices, inflation and the economic outlook can alter the context around a decision, as explored in our analysis of the ECB rate decision, oil and inflation. Policymakers also have to consider how different inflation shocks should be treated; ECB chief economist Philip Lane has discussed medium-sized inflation shocks and the ECB’s 2% target.
For readers following the potential path of policy rather than only the current rate, Finance Gazette also examines how high ECB interest rates could go.
Although these systems operate differently, the underlying purpose is similar: central banks influence the cost and availability of money and credit, affecting spending, saving, investment, economic activity and inflation.
Interest rates change for many reasons, but central-bank decisions receive the most attention.
Inflation is particularly important. When inflation remains too high, a central bank may raise its policy rate. Higher rates tend to make borrowing more expensive and saving more attractive.
This may reduce household spending and business investment. Slower demand can then reduce the pressure on businesses to raise prices.
The simplified transmission process is:
Higher policy rates → more expensive credit → less borrowing and spending → weaker demand → less inflationary pressure
When economic activity is weak or inflation is below target, a central bank may lower rates. Cheaper borrowing and reduced returns on saving can encourage spending and investment.
However, the effect is neither immediate nor guaranteed. Rate changes can take months or years to work through an economy. Higher rates also cannot directly produce more oil, food, computer chips or other goods when inflation has been caused by supply shortages.
That distinction matters because inflation can arise from sources monetary policy cannot quickly fix. Recent examples of the wider data central banks and investors may watch include changes in US grocery prices alongside SNAP enrolment and persistent supply constraints in sectors such as semiconductors, where Finance Gazette has examined the Samsung Electronics and SK Hynix chip-supply outlook.
Trade policy can add another layer. Tariffs may affect import costs, business decisions and inflation depending on their scale and how companies respond. Finance Gazette has covered both US Section 301 tariff measures affecting dozens of economies and the wider Canada–US tariff debate involving Mark Carney and Donald Trump.
Central banks therefore consider employment, wages, economic growth, inflation expectations, credit conditions and international developments—not only the latest inflation figure. One useful labour-market measure is the relationship between available workers and open positions; Finance Gazette has analysed the rise in the number of UK unemployed people per vacancy in 2026.
For a more detailed explanation, read our guide to why interest rates rise and fall.
Higher rates can increase the cost of mortgages, personal loans, credit cards and business borrowing. The effect on an existing borrower depends on the agreement.
Someone with a fixed-rate mortgage may see no immediate change when the central bank raises rates. Their payment would normally remain unchanged until the fixed period expires.
A borrower with a tracker or other variable-rate loan may be affected much sooner.
The connection between policy rates and mortgage pricing can also be seen in the United States, although mortgage rates are influenced by bond yields and other market factors rather than simply mirroring the Federal Reserve’s policy rate. Finance Gazette has examined this in its coverage of Freddie Mac’s US mortgage-rate data.
The following example shows the approximate cost of a £200,000 repayment mortgage over 25 years, assuming the stated rate applies throughout and excluding fees:
| Mortgage rate | Approximate monthly payment | Approximate total interest |
|---|---|---|
| 3% | £948 | £84,527 |
| 5% | £1,169 | £150,754 |
| 7% | £1,414 | £224,068 |
These figures are illustrations rather than product quotations. Actual payments depend on the lender’s calculation method, fees, rate changes and mortgage terms.
The example demonstrates why a difference of a few percentage points can have a major effect on long-term borrowing.
Higher interest rates can provide better returns on savings accounts and deposits. Commercial banks are not normally required to match each central-bank change, however. Savings rates also depend on the product, access restrictions, competition and the bank’s need for deposits.
Savers should distinguish between nominal and real returns.
Suppose an account earns 5% in a year while prices rise by 3%.
A quick estimate of the real return is:
5% − 3% = 2%
The more precise calculation is:
1.05 ÷ 1.03 − 1 = approximately 1.94%
The saver earned 5% in cash terms but increased their purchasing power by approximately 1.94%, before tax and costs.
If inflation exceeds the savings rate, the account balance can increase while its purchasing power falls.
Businesses frequently borrow to finance:
When interest rates rise, prospective investments must generate a higher return to justify their financing costs.
A project may be attractive when a company can borrow at 4% but uneconomic if its borrowing cost increases to 8%. Businesses may consequently delay investment, recruitment, acquisitions or property purchases.
Rates can also affect companies indirectly by changing consumer demand, exchange rates and the financing costs of customers and suppliers. The effect is not uniform across businesses: Finance Gazette’s recent analysis has looked at the financial pressure around John Lewis Partnership’s £124 million loss and the level of second-half improvement required in Wickes’ profit growth.
Companies also have alternatives to conventional borrowing. They may raise equity instead, accepting potential dilution in exchange for new capital. The trade-off can be seen in Corning’s $2 billion at-the-market equity facility and its implications for dilution, capital expenditure and liquidity.
Interest rates influence the value and relative attractiveness of many financial assets.
Existing fixed-rate bond prices generally move in the opposite direction to market interest rates.
Suppose a bond pays fixed annual interest of £30. If newly issued comparable bonds begin paying £50, investors will normally be unwilling to pay the original price for the £30 payment. The older bond’s market price must fall to offer a more competitive yield.
The reverse can happen when market rates fall.
Changes in rate expectations can also affect investor flows into and out of bond funds. Finance Gazette has examined this through LSEG Lipper data on investment-grade bond outflows and Federal Reserve expectations.
Higher rates can increase companies’ financing costs and reduce consumer demand. They can also increase the rate investors use to value future company profits, which may reduce the present value assigned to those profits.
At the same time, higher rates can make cash deposits and bonds more attractive compared with shares.
But the relationship is not simply “rates rise, shares fall.” Markets also respond to why rates are changing, company profits, economic growth, inflation expectations and whether the decision had already been anticipated. Company-specific developments can easily dominate the rate effect over shorter periods, as illustrated by Finance Gazette’s analysis of Qualcomm’s profit and falling handset revenue.
Interest rates can also influence exchange rates because they affect the relative return available on assets denominated in different currencies. All else being equal, higher rates may make a currency more attractive to some investors, while lower rates can reduce that attraction.
In practice, currencies respond to far more than the current policy rate. Expectations about future rates, inflation, economic growth, trade flows, fiscal policy and political developments can all matter. Governments and central banks may also become involved directly in foreign-exchange markets, which is why it is important to distinguish currency intervention from currency manipulation.
Recent debate around the yen illustrates how complex the distinction can become. Finance Gazette has examined US Treasury, ECB, euro and yen intervention issues as well as Scott Bessent, the US Treasury and possible Japanese yen intervention.
Interest-rate differences are therefore one influence on currencies, not a complete explanation for exchange-rate movements.
A fixed interest rate remains unchanged for an agreed period.
For borrowers, fixing provides certainty over the rate and, in many cases, the required payments. If market rates rise, the fixed rate normally remains unchanged until the fixed period ends.
The trade-off is that a borrower may remain on a relatively expensive rate if market rates fall. Charges may also apply for ending some fixed-rate agreements early.
A variable interest rate can change in accordance with the product’s terms.
Some variable rates track a published benchmark or central-bank rate. Others are set by the lender and may change subject to the contract and relevant consumer-protection rules.
Variable-rate borrowers therefore have greater exposure to changing interest-rate conditions.
A nominal interest rate is the stated rate before adjusting for inflation.
A real interest rate measures the return or cost after accounting for changes in purchasing power.
If savings earn 2% while prices rise by 4%, the saver has more money numerically after one year, but that money will generally buy less.
Real rates are therefore important when assessing savings, investment returns, borrowing costs and monetary policy.
These terms are related but are not interchangeable.
| Term | Primarily used for | What it indicates |
|---|---|---|
| Interest rate | Borrowing and saving | The rate applied to the balance |
| APR | Borrowing | An annualised comparison measure that can incorporate interest and certain charges |
| AER | Savings in the UK | The annual return after allowing for compounding |
APR, or Annual Percentage Rate, is intended to make borrowing products easier to compare. The precise calculation and the charges included depend on the jurisdiction and product.
AER, or Annual Equivalent Rate, shows what a UK savings account would earn over a year if interest were paid and compounded according to the product’s terms.
A product with a low interest rate but substantial fees may be more expensive than its headline rate suggests. Likewise, two savings accounts displaying similar nominal rates may provide different effective annual returns.
A basis point is one-hundredth of a percentage point.
A rise from 4% to 4.25% is therefore an increase of 25 basis points, not a 25% increase.
Using simple annual interest, an additional 0.25 percentage points would have the following effect:
| Balance | Additional interest over one year |
|---|---|
| £1,000 | £2.50 |
| £10,000 | £25 |
| £100,000 | £250 |
| £1 million | £2,500 |
| £1 billion | £2.5 million |
Actual loans and savings products may behave differently because of repayments, compounding, fees and contractual terms. Nevertheless, the table demonstrates why apparently small rate movements matter when applied to mortgages, company borrowing, government debt and entire financial systems.
Interest rates connect areas of finance that can initially appear unrelated.
A central bank changes a policy rate. That affects financial markets and banks’ funding conditions. Those changes can feed into mortgages, savings accounts, company borrowing, bond prices and stock-market valuations.
Households may change how much they borrow, save or spend. Businesses may reconsider investments. Investors may reassess the price of bonds and shares.
Together, those decisions affect economic activity and inflation.
Interest rates are therefore more than percentages displayed beside loans and savings accounts. They are one of the principal mechanisms through which the price of money influences financial decisions across an economy.
Neither in isolation. Higher rates can benefit savers while increasing costs for some borrowers. Lower rates may reduce borrowing costs but also reduce savings returns. The wider consequences depend on why rates are changing and the state of the economy.
Not directly. Policy rates influence market conditions, but lenders determine their mortgage rates based on funding costs, market expectations, borrower risk, product structure and competition.
No. £5 is 5% of £100, but the amount actually paid or earned depends on how long the rate applies, whether interest compounds, whether the balance changes and whether fees apply.
Yes. Some central banks have used negative policy rates. That does not mean every consumer is automatically paid to borrow. How negative policy rates affect commercial loans and deposits depends on the financial system and the terms of individual products.
Borrowing may become cheaper, although lenders do not necessarily pass on the full reduction immediately. Savings returns may fall. Lower rates can encourage borrowing, spending and investment, but their impact depends on confidence, credit availability and wider economic conditions.
Check the applicable rate, whether it is fixed or variable, how frequently interest is calculated, the total repayment or return, fees, penalties and any introductory period. For borrowing, APR can assist comparison; for UK savings, AER is generally the more useful standardised measure.
