We have seen interest rates go up and down regularly over the years. However, between December 2021 and early 2023, there have been consistent monthly increases. Changes in interest rates from the Bank of England (BoE) can have a significant impact on households and businesses. However, despite the effect that interest rate movement can have on the nation, many are still unaware of how the BoE makes essential decisions relating to interest rate movement.
The role of the Monetary Policy Committee
There are various factors the BoE has to take into consideration when making an interest rate decision. Over recent months, we have seen the interest rate rise month after month, usually by 25 basis points, but sometimes more. This has made life difficult for people struggling with rising food costs, energy price increases, and growing mortgage rates.
When it comes to how the BoE makes interest rates decisions and sets interest rates, it is essential to know the role of the Monetary Policy Committee (MPC). Members of the MPC meet eight times a year after a briefing by staff from the central bank.
The MPC discusses the data from economists and staff at the BoE over several days. The aim of this is to look at what the MPC needs to do to achieve its goals and reach or maintain targets. These decisions often involve interest rates being adjusted by a certain number of percentage points. How much interest rates move depends on the data from the central bank, the goals the MPC needs to meet, and MPC members’ personal views and opinions.
One noticeable trend in interest rate movement from the MPC is that it often follows interest rate movements from the US Federal Reserve. While there are no official ties between the two central banks, the US is the world’s biggest economy, naturally impacting the rest of the world. As many industry experts say, when New York sneezes, London catches a cold.
The actions taken by the MPC regarding the base rate can vary from one meeting to the next and can depend on everything from the UK economy and the economic outlook to inflationary pressures and the need to get back within the inflation target.
The latter is something that we have seen since the end of 2021, with inflation soaring to its highest level in decades. As a result, the BoE governor Andrew Bailey has made it clear throughout the last 12 months that aggressive action would need to be taken by the MPC to try and get back within target.
However, this was a real challenge for policymakers due to global influences, including the continued impact of the Covid-19 pandemic, soaring energy costs, and the war in Ukraine, all of which impacted UK inflation and inflation levels around the globe.
What do the MPC and BoE consider when making interest rate decisions?
The UK has had much to deal with over the past few years. Around the same time as Brexit, the devastating pandemic hit and significantly impacted the nation and economy in many ways.
We’ve seen terrible decisions that compounded economic problems, such as the mini-budget from the then-chancellor, Kwasi Kwarteng, under the Liz Truss administration. While both are no longer in office, the BoE still has many challenges. These challenges have resulted in the MPC raising rates regularly over the past 12 months.
Inflation is one of the critical factors that the BoE and MPC have to consider when it comes to setting interest rates. With inflation soaring over the past year, we have seen one interest rate hike after another from the central bank. In fact, it has reached a point where there are fears of a recession, which could significantly impact the economy.
With the rise of interest rates, consumers and businesses have been hit with soaring borrowing costs on top of the cost of living pressures they face. Inflation hit double digits for the first time in decades, so many of those affected by soaring interest rates found themselves facing a new situation, having become used to historically low interest rates.
While many hope that interest rate increases will be short-term, some believe soaring inflation could continue to be a massive issue over the remainder of 2023 and into 2024.
Of course, interest rates can fall as well as rise, resulting in historically low rates over recent years until inflation rocketed. The decision to reduce interest rates comes when spending levels are low, which negatively impacts employment levels and the economy as a whole.
The MPC might cut interest rates to boost spending and improve economic activity. This means that borrowing costs will fall, people will have more disposable income, and spending will generally increase. It also means that borrowing increases, as lower interest rates equate to increased affordability for consumers and businesses.
In short, the MPC must consider a wide range of economic data from the BoE when making interest rate decisions. The committee has the difficult decision of deciding whether to implement an interest rate hike to reduce inflationary pressure, which can then lead to an economic slowdown. Or, they must decide whether to lower interest rates to boost a slowing economy and tackle rising unemployment, among other things.
What lies ahead from the BoE and MPC?
The UK has seen a lot of turbulence over the past couple of years, from sterling hitting record lows after the mini-budget to the impact of Brexit, the pandemic, the Russian war against Ukraine, and more.
It is little wonder that many have no idea what to expect over the remainder of this year and into next year when it comes to the BoE base rate. The central bank continues to struggle to reach its benchmark for inflation, putting it and the MPC in a difficult position as they have to strike a balance between economic activity and soaring inflation.
Of course, all central banks around the globe face the same difficulties due to the impact of global factors, including the US Federal Reserve and the European Central Bank, among others. In the challenging and turbulent situation that most nations now find themselves in, what comes next from both the BoE and other central banks worldwide remains to be seen.