On February 2, 2023, the Bank of England announced that it will rise interest rates for the tenth consecutive time. The 0.5% increase brings interest rates to 4%, the highest level in 14 years. The decision was taken in response to rising inflation, which has been a major concern for policymakers in recent months.
The move, widely expected by markets, highlights that the fight against inflation is a priority for the Bank of England, despite the weakness of the British economy, which is on the brink of recession. The inflation rate dropped to 10.5% in December 2022 from 11.1 % recorded in October, but remains well above the target rate of 2%.
In fact, partly due to these measures, Bank of England analysts reckon inflation will decrease to 8% in June 2023 and could fall to 3% by early 2024.
A major driver of inflation in the United Kingdom has been rising energy prices. The cost of natural gas, used to heat homes and power factories, has risen due to a number of factors – including complications of the conflict in Ukraine, supply shortages, and increased demand in Asia. This led to higher energy bills for consumers and higher costs for businesses, resulting in higher prices for goods and services.
Other factors that have contributed to higher inflation in the UK are supply chain interruptions due to worker shortages in some sectors.
Such high levels of inflation have important consequences for the UK: as a matter of fact, this situation brought about a decrease in the purchasing power of the currency, as consumers are able to buy fewer goods and services with the same amount of money. Consequently, the decision of raising rates was taken to slow economic activity and reduce demand for goods and services, with the intent to bring inflation back to normal levels.
Moreover, rising interest rates have important economic and financial consequences, which can then spread to the real and social level.
First, it makes borrowing more expensive – this can discourage people and businesses from borrowing, resulting in slower economic activity. For instance, if mortgage interest rates rise, fewer people can afford to buy a home, which can lead to a decrease in demand for housing and a general slowdown in the construction industry, jeopardizing the whole economic environment.
Second, it can lead to an increased appreciation in the value of the currency – indeed, higher interest rates can make a country’s assets more attractive to foreign investors, which can lead to an increase in demand for currency. An increase in demand for currency can ultimately lead to an increase in its value relative to other currencies, thus making imports cheaper and exports more expensive and impacting positively on international trade.
Finally, rising interest rates will have an impact on savers – more specifically, it means that bank account holders will earn more interest on their savings and this can be good news for those who rely on their savings for income, such as retirees.
In conclusion, The Bank of England’s decision to raise interest rates was based on a careful analysis of a wide range of economic indicators and it is aimed to balance the competing objectives of controlling inflation, maintaining financial stability, and promoting economic growth.
However, while raising interest rates can help reduce inflation and encourage savings, it can also lead to higher borrowing costs for individuals and businesses, resulting in slower economic growth and must be cautiously monitored.