Why is BoE raising interest rates. I understand the normal reasons, but we are not in normal

spudboater

So i understand the basics behind raising interest rates to control inflation. In normal economic times this makes some sense.

And it strikes me that rising interest rates in today's economic environment will in fact fuel inflation, not the reverse. 

We have a cost of living "crisis" people are not spending, so how does raising interest control the spending we are not doing. In fact, making borrowing cost more means we borrow more and forces us to campaign for higher pay, which in turn drives the cost of goods/services we work on to go up, which in turn drives up inflation. Vicous cycle.

It strikes me that interest rates are high, and deliberately being kept high, to adjust for all the money we printed during COVID.

Anyone want to correct me ?

Thumbs_Up

Base bank rate is not high, if you look back in history, say 200years.

 

Linton

The objective of increasing interest rates is to stop rising prices of goods leading to rising wages which in turn leads to further  increase in the price of goods, and so on to hyperinflation.  The theory is that overall there is less money in circulation as people and businesses would be likely to save more and borrow less.  Less money around means more market pressure on businesses selling goods who are therefore discouraged from raising prices and so cannot afford to increase wages.

Historically interest rates are not high, if anything a bit low.    It is the previous couple of decades which were unusually low.

Sg28

Firstly interest rates aren't high. Yet.

The problem is that people are still spending.

If rates are low and money is cheap people borrow and spend more, and there's no incentive to save so might aswell spend it instead. If rates are high more people save and less people borrow to spend. 

High inflation is partly due to covid imo. So much free money was handed out and pumped into the economy, possible the reason so few people seem to be too badly effectived by high inflation. 
Also the effect of over a decade of near 0 interest rates has not helped. 

I believe that rates should have been gradually rising for 5 or even 10 years. I dont think would be seeing such a fast and painful rise(for mortgage holders) or potentially as high a spike as we might do.

But 4 to 6% rates are inevitable one way or the other and its unlikely we will see such low ever again. Barring a major economic catastrophe.

wmb194

spudboater said:

So i understand the basics behind raising interest rates to control inflation. In normal economic times this makes some sense.

And it strikes me that rising interest rates in today's economic environment will in fact fuel inflation, not the reverse. 

We have a cost of living "crisis" people are not spending, so how does raising interest control the spending we are not doing. In fact, making borrowing cost more means we borrow more and forces us to campaign for higher pay, which in turn drives the cost of goods/services we work on to go up, which in turn drives up inflation. Vicous cycle.

It strikes me that interest rates are high, and deliberately being kept high, to adjust for all the money we printed during COVID.

Anyone want to correct me ?

You cannot envisage a scenario where people stop borrowing more and instead cut back on their discretionary spending and even work to cut their debt? Good risk free deposit rates and more expensive debt might even encourage saving. Less spending and more saving might work to affect demand pull inflation.

grumbler

spudboater said:

In fact, making borrowing cost more means we borrow more and forces us to campaign for higher pay, which in turn drives the cost of goods/services we work on to go up, which in turn drives up inflation. Vicous cycle.

Only if we get what we are campaigning for.

ETA: 

borrowing cost more means we borrow more

Strange logic. That's like saying that, e.g. the higher energy costs the more we heat our houses.

housebuyer143

Raising interests rates is the only thing they can do so it's that or nothing. They can't do nothing.

People haven't really cut back yet, and you only need to read some comments on this savings board to see there is a lot of money kicking about. I don't see people struggle at the moment when I go out, I see more people than ever eating out, having home improvements etc. Most the rate rises haven't impacted the majority when it comes to mortgages at the moment either. 

People are getting more pay because the job market is tight and work places need to pay more to attract people, which is fueling inflation (ironically one of the points of Brexit was that lower paid workers couldn't come and drive down wages), and so yes it's then a vicious cycle.

wmb194

If you want a contemporary example of what happens when you don't raise rates when you ought to just look at Turkey's current situation.

daveyjp

You also need to look across the pond. Strength of dollar v pound has a huge effect on our economy.

MattMattMattUK

The main reason that the BoE are raising interest rates is not directly linked to inflation, but is actually to do with protecting the value of Sterling. If the BoE base rate dropped too far below the rates set by the Fed or the ECB then Sterling would loose value and it is already weak. Sterling falling in value would further compound inflation so failure to act would make inflation worse.

Imvrasos

OP think in terms of new money being created when a customer takes a loan, and destroyed when the loan is paid. Higher interest rates increase borrowing costs and incentivise both individuals and businesses to pay their existing loans (money is now being destroyed/removed faster), and restrict further lending (new money creation slows down).

In theory this should reduce the money supply in the economy and reverse the perverse devaluation of sterling we see unfolding since the 'invention' of QE-style money printing and more recently through the covid-triggered helicopter money.

However considering the recent timid and anemic movements from BoE, setting a bank rate that's about half the formal inflation figures, tells me that both the government and its central bank are in no hurry to stop the pound's purchasing power decline.