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I'm currently revising for my AS economics exam and I am going over Monetary Policy. In a handout, I've read the following phrases which I am a little confused about...

"A cut in the base rate, assuming it reduces market interest rates across the economy..."

This quote implies that the Bank Rate only changes the Central Bank's Interest Rate not the IR for commercial banks; so therefore, how are IRs determined in commercial banks? Do they have to be within a certain range of the Bank Rate? (Otherwise what is the point of influencing the Bank Rate if commercial banks are not forced to comply?).

"An increase in the base rate will not only reduce post-debt repayment income..."

This implies that mortgages etc. vary depending on the IR rate rather than being a fixed amount independent of changes in the IR (which is what I thought it was).

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up vote 1 down vote accepted

Interest rates in commercial banks are determined by market forces - supply and demand.

Their demand will be influenced by their customers' expectations - which will be influenced by the Central Bank interest rate. Their supply will be influenced by the Central Bank (the Bank of England) interest rate.

Some UK mortgages have fixed interest rates for a particular term - for example, the first three or five years of the mortgage. After that, they revert to the standard variable rate, which loosely tracks the Central Bank interest rate plus a few percentage points.

Some UK mortgages are trackers - that is to say, they are designed so that they track the Central Bank interest rate plus a fixed offset, and they change very quickly when Central Bank rates change: if the Central Bank rate changes by x%, then within one day to one month, the tracker interest rates also change by x%.

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