Understanding the Price of New Lending to Households

Richard Button, Silvia Pezzini and Neil Rossiter

Banks and building societies provide important services to households and businesses, intermediating saving and borrowing, providing payment services and distributing risk. The interest rates at which lenders extend credit are important for both monetary policy and financial stability. They will affect spending and investment decisions and so influence nominal demand in the economy. And they will affect the profitability of lenders and so – if profits are retained – influence the flow of new capital available to the banking sector.

In the UK, the Monetary Policy Committee (MPC) is able to influence new lending rates through changes to the interest rate the Bank of England pays on the reserve balances held by banks and building societies: Bank Rate.¹¹Changes in new lending rates will influence inflation principally through domestic demand. But changes in Bank Rate also influence inflation via movements in asset prices, the exchange rate and expectations/confidence affecting domestic demand, external demand and import prices. But while Bank Rate was reduced significantly during the 2007–9 financial crisis, new lending rates to households fell by a much smaller amount, and in some