Interest rates have been increased from 0.1% in December 2021 to 5.25% in August 2023, following 14 consecutive meetings where the Bank of England decided to raise the rates.
These increases were made in response to high inflation, which had peaked in October 2022 at a CPI of 11.1%.
Interest rates and inflation tend to move in the same direction, as rates are the primary tool used by banks to manage inflation. Historical data has shown that when interest rates are low, inflation tends to rise.
The Bank of England has used high interest rates to slow down spending during periods of rapid economic growth.
The reasoning behind this initiative is that, when interest rates increase the cost of borrowing rises and this mean that borrowers have less chances to spend. It also means that if you do have cash, you might be more likely to lock it away in return for higher interest payments on accounts like fixed rate bonds.
Inflation in England was not cause by individual overspending or high growing economy rather than economic and geopolitical factors.
Britain is the world’s third-largest net importer of food and drink, according to the Food and Agriculture Organization of the UN. The Office for National Statistics noted that the inflation rate for food prices reached 19% in 2023. This increase was due to freak weather conditions that affected crops worldwide, leading to higher prices in many countries.
For the past three years, the world has been dealing with a gas price crisis, which was further exacerbated by the Russian invasion of Ukraine. The International Monetary Fund reported that England was the hardest-hit country in Western Europe due to its heavy dependence on gas for electricity generation and heating homes.
The Brexit referendum has led to increased uncertainty regarding future trade conditions between the EU and the UK and the COVID-19 pandemic has also contributed to a surge in inflation.
Lockdowns, especially in China and Asia, have disrupted the global supply chain. When demand returned in 2022, the just-in-time management of supply chains broke down.
Global shipping experienced a rapid rise in prices due to a shortage of transport shipping in the ports where they were needed. This shortage led to an increase in transport prices for many manufactured goods, which were then passed on to consumers.
Lastly, during the COVID-19 lockdowns, there was a sharp rise in personal savings as risk-averse consumers reduced spending. As the economy and society reopened, many households had large savings they could now spend. Higher rates slowed down the economy and reduced demand-pull inflation.
Bank of England is expected to hold interest rates at 5.25% which is its highest level in 15 years.
The BOE has raised the base rate 14 times since December 2021 to reduce the UK’s annual inflation rate which has now fallen to 2.3%. While this is now close to the BOE’s target rate of 2%, the latest inflation number was higher than expected. The BOE has stated that it will not hesitate to raise interest rates further if inflation proves persistent.
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