With the cost of living soaring and some previous essential items now being deemed a luxury it can be hard to fathom why the Bank of England would make borrowing money more difficult.

The Bank of England has hinted it will continue to increase interest rates in a bid to bring inflation back to 2% as tasked by the Government. 
This is the only thing that the UK’s central bank can control.

Following a 40-year high in inflation the interest rate has been raised six times since December 2021 to try to stop the soaring cost of living.

So how do higher interest rates help to bring down inflation?

According to the Bank of England website, ‘Higher interest rates make it more expensive for people to borrow money and they also encourage people to save.
The result is that, overall, people will tend to spend less.
If people spend less on goods and services overall, then the price of those things tend to rise more slowly. Slower price rises mean a lower rate of inflation.’

This means consumers and businesses will be put off spending and borrowing.

Before December interest rates were so low that people were encouraged to borrow money, the knock on effect was that rates on savings accounts were also low, so there was little incentive to save meaning spending was in favour.

Why does borrowing then become so expensive?

The Bank of England state …
‘We set the UK’s key interest rate, Bank Rate. It’s more widely known as ‘the base rate’ or just ‘the interest rate’.
It influences all the UK’s other rates including any you might have for a loan, mortgage or savings account.’

Why is inflation so high?

Higher energy prices are one of the main reasons why inflation is so high.  
Since May, the price of gas has doubled.   The Bank of England think that those price rises will push inflation even higher over the next few months, to around 13%.

Higher prices for the goods we buy from abroad have also played a big role and people selling these have had problems getting enough of them to sell. That led to higher prices.

Also businesses are charging more for their products because of the higher costs they face.
As demand for goods and services fall, this should in theory effect prices by preventing costs from rising.  Shops might even reduce the cost of goods to try to encourage people to buy them.
This is why increasing the Bank rate is like a lever for slowing down inflation.

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