Real interest rate

A “real” interest rate accounts for the impact of inflation on a given rate of interest. It’s very important to your returns.

Interest rates on things such as savings accounts or bonds are normally quoted in "nominal" terms, where inflation has not been taken into account. A "real" interest rate accounts for the impact of inflation on a given rate of interest, and it's very important to your returns.

Say you put £100 into a savings account that pays an annual interest rate of 5%. After a year, you will have £105. But if inflation is running at 3% a year, then a basket of goods that cost £100 a year ago will now cost £103. So in reality, your buying power has only increased by £2 (£105 less £103). The real interest rate takes this into account so your real interest rate on the £100 deposited is 2% (£2/£100), not 5%.

Advertisement - Article continues below

The simplest way to work out the real interest rate is to take the nominal rate and subtract the rate of inflation in this case 5% less 3%. The yields on index-linked bonds do take the rate of inflation into account and tend to be quoted in real terms in newspapers or on financial websites.

Real interest rates have fallen significantly since the financial crisis, due to rates falling more rapidly than inflation. In some cases they are even negative. This means owners of bonds and many of those with savings have been losing money in real terms.




Real exchange rate

The real exchange rate between two currencies combines the nominal exchange rate with the ratio of the price of goods or services in two different cou…
26 Jun 2020

ESG investing

ESG stands for environmental, social and corporate governance, the areas in which good behaviour is particularly sought.
19 Jun 2020

FAANG stocks

The acronym FAANG refers to Facebook, Amazon, Apple, Netflix and Google (Alphabet) – five American companies that have been among the top-performing s…
12 Jun 2020

Technical analysis

Technical analysts or 'chartists' attempt to predict future share price (or index) movements by looking at past movements.
5 Jun 2020

Most Popular


House price crash: UK property prices are falling – so where next?

With UK property prices falling for the first time in eight years, are we about to see a house price crash? John Stepek looks at what’s behind the sli…
2 Jul 2020

The end of the bond bull market and the return of inflation

Central bank stimulus, surging post-lockdown demand and the end of the 40-year bond bull market. It all points to inflation, says John Stepek. Here’s …
30 Jun 2020

How can markets hit new record highs when the economy is in such a mess?

Despite the world being in the midst of a global pandemic, America's Nasdaq stock index just hit an all-time high. And it's not the only index on a bu…
3 Jul 2020