What influences the Bank of England interest rate? and what effect does it have, i.e why do we care so much?

Answer 1

The monatary policy committee sets the interest rate. They are meant to be solely influenced by the rate of inflation. If it rises above a certain target they are tasked to bring it down by raising interest rates. If interest rates are higher the borrowing "money" becomes more expensive, people will spend less (less money supply), and thus the pressure to raise prices decreases. If you have less money to spend, shops and service providers have to keep their prices lower to sell.


If interest rates rise you are effectivly poorer, and it puts upwards pressure on the unemployment levels. Lower interest rates are usually regarded as better by most people.

Answer 2

The BoE interestrate is important to us normal people because it has a direct impact on our lives.

In general, the BoE interest rate is the rate at which commercial banks can borrow from the BoE in emergency. Therefore, the commercial banks tend to base themselves on the BoE rate to set their own interest rates. When the BoE rate rises, the interest rate on your floating rate mortgage is most likely to rise and you pay more.

That is why the BoE interest rate matters directly to us.

The BoE is supposed to have the mission of inflation targetting; that is they use interest rates as a means to prevent inflation. In general, if they see prices increasing, they will increase rates so that people borrow less, spend less, and thus prices stop rising, decreasing inflation.

There are 2 main causes of inflation: demand pull - we buy more and more, more than what can be supplied, so prices rise, and supply push - say oil prices across the world rise and costs of production rise, pushing all prices up.

In case of demand pull, it stands to reason that if people are borrowing to spend, then increasing interest rates will cause a slow down in inflation. This applies to individual as well as government spending. However, while government spending itslef might not decrease that much in response to the interest rate increase, it will 'crowd-out' private spending. So interest rates can mitigate demand pull inflation.

Note that such inflation targetting by the BoE can give license to the government to spend, knowing the BoE will adjust rates to calm inflation. So this system isn't necessarily perfect.

In the case of cost-push, the situation is not that clear cut. Since all prices are rising, increasing interest rates doesn't seem to have much concrete effect other than increasing costs of doing business further. This can actually push some companies into the red, causing more problems to the economy rather than solving anything. (This is precisely the bad medicine the IMF force fed Indonesia in the wake of the financial crisis; Indonesia is far from ercovering).

Answer 3

The inflation rate does. Government has been criticised for playing around with the inflation measure by failing to include costs such as petrol, car expenditure, council tax, mortgage repayments etc. Although inflation appears low according to the government, it hasn't gone away, it has moved into the public sector and hits us in the form of taxation. The rate of interest is extremely important for mortgage payers, and for people on the other side of the equation who rely on interest received on their savings.

The Government make great play by the fact that they have given the BOE Independence in setting interest rates; but it is the inflation target that determines the rate they set, and it is the Government that sets the inflation target, and it is also the Government that decides which inflation measure should be used and how the measure itself is calculated. So, the BOE doesn't really have as much Independence as people might think.

Answer 4

inflation targets; economic growth