The Bank of England's interest rate decisions remain under intense scrutiny as the UK economy grapples with persistent challenges to its growth. The central bank's Monetary Policy Committee has held the rate at 4%, a level that continues to guide the cost of borrowing across the nation.
The Central Bank's Balancing Act
Central banks, including the Bank of England, possess a powerful tool: the ability to change the base interest rate. This rate, also known as the Bank Rate, is reviewed and set every six weeks. It acts as a benchmark, directly influencing the interest rates that high street banks, building societies, and credit card providers set for mortgages, loans, and savings accounts.
Why Interest Rates Are Increased
The primary reason for increasing the base rate is to control inflation, which is the rate at which prices for goods and services are rising. When the Bank of England raises rates, it makes borrowing more expensive. This increase directly impacts mortgage repayments and loan costs, which in turn discourages consumer spending.
Concurrently, higher rates make saving money more attractive, as returns on savings accounts improve. This dual effect—reduced spending and increased saving—cools overall demand in the economy. In theory, this slowdown in demand helps to slow down the pace of price increases, bringing inflation under control.
However, this mechanism does not always work perfectly. As seen during the recent cost of living crisis, when inflation is driven by external, volatile factors like a global energy price shock, raising interest rates has a more limited effect. This complexity is why inflation proved so difficult to tame, even with policy adjustments.
Why Interest Rates Are Lowered
Conversely, the Bank of England may decide to cut interest rates to stimulate a sluggish economy. Lower rates make borrowing cheaper, encouraging both individuals and businesses to take out loans for spending and investment. This boost in activity stimulates demand, which can help fuel economic growth.
This strategy is often deployed when reviving the economy is deemed a more immediate priority than controlling inflation. Nevertheless, it is a delicate balancing act. If the central bank stimulates demand too aggressively, it risks causing inflation to start creeping up again. Currently, UK inflation stands at 3.8%, which is almost double the Bank's official 2% target but significantly lower than its peak during the height of the cost of living crisis.
With the base rate held steady for now, experts are predicting a potential cut as soon as December, as the Bank continues its careful navigation between fostering growth and ensuring price stability.
