This page was last updated on 19 September 2024
Why are interest rates high and how quickly might they fall?
We began raising interest rates at the end of 2021 to help reduce inflation.
It is working. Inflation has fallen a lot and is now just above our 2% target. Inflationary pressures have eased enough that in August we cut the interest rate from 5.25% to 5%.
If those pressures continue to ease, we should be able to further reduce interest rates gradually. But it’s vital that we make sure inflation stays low, so we need to be careful not to cut rates too quickly or by too much.
We make our decision on interest rates every six weeks or so. Each time, we look at the state of the economy and what we expect for the coming months. The factors we consider include:
- how fast prices are rising
- how the UK economy is growing
- how many people are in work
Our next decision will be announced on Thursday 7 November 2024. You can see our full list of upcoming dates along with links to our more detailed reports.
Current Bank Rate 5%
Next due: 7 November 2024
What links the cost of living and inflation?
The prices you pay at the supermarket, the petrol pump and many other places have risen quickly in recent years. Inflation is the measure of the speed of those increases.
When prices are rising quickly, it means inflation is high and you can’t buy as much with your money. Therefore, the cost of living is higher.
The government sets us a target of ensuring inflation is low and stable at 2%. As the UK’s central bank, the best tool we have to slow down the rate of rising prices is interest rates.
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The Consumer Price Index (CPI) is a way of measuring inflation. It tracks how the prices of a shopping basket of about 700 items are changing. That basket is designed to represent what people buy on average, and includes food, household bills and transport.
For example, if CPI inflation is 2% then a basket that was £100 a year ago would be £102 today.
Between 1997 and 2021, CPI inflation was 2% on average – in line with our target. It began to rise in 2021 and reached a peak of 11% in 2022. It has fallen back to about 2% since then.
Inflation in the UK is measured by the Office for National Statistics.
How do higher interest rates bring inflation down?
Interest rates influence how much people spend, and that changes how shops and other businesses set their prices.
Higher interest rates mean higher payments on many mortgages and loans, meaning people must spend more on them and less on other things.
It also means savers get more return and potential borrowers find it is more expensive to take out a loan. These things make it less attractive for consumers and businesses to spend money.
When customers spend less, businesses are less willing or able to raise their prices. When prices don’t go up so quickly, inflation falls.
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The Bank of England sets the UK’s base interest rate, Bank Rate. It’s also sometimes known simply as ‘the interest rate’. Bank Rate influences the level of all other interest rates in the UK.
Bank Rate was almost zero (0.1%) at the beginning of December 2021. It is 5% now.
In the years between 1975 and 2007, Bank Rate was 3.5% at its lowest point and 17% at its highest. We cut it to 0.5% during the global financial crisis in 2008 and 2009. We kept it low after that, in order to support the UK economy.
Higher interest rates increase the return on savings. They also make the cost of borrowing more expensive.
Higher interest rates help to slow down price rises (inflation). That’s because they reduce how much is spent across the UK.
Experience tells us that when overall spending is lower, prices stop rising so quickly and inflation slows down. That has started to happen in the UK. We need to make sure it continues to happen.
People have told us directly that they are finding higher mortgage and loan payments very hard. They also ask if higher interest rates are the best option we have.
The answer is yes. The UK government sets us a target of getting inflation to 2%. And interest rates are the best tool we have to slow down price rises.
We know that interest rates are an effective tool for managing inflation, because they have been used successfully across many countries and circumstances. They are effective in influencing the amount of spending in the economy, and therefore inflation. And we can see that they are working now.
Why is my loan or saving interest rate different to the Bank Rate?
Bank Rate is the interest rate that we pay to commercial banks that hold money with us. Because of that, changes in Bank Rate influence the rates other banks charge people to borrow money or pay them on their savings.
But Bank Rate isn’t the only thing that affects interest rates on saving and borrowing. Interest rates can change for other reasons and may not change by the same amount as the change in Bank Rate.
Further, to cover their costs banks normally pay less to savers than they charge to borrowers. So, there’s usually a gap between interest rates on savings and loans.
Who makes the decision on interest rates?
A group of nine people are responsible for setting Bank Rate. They are members of our Monetary Policy Committee (MPC).
The MPC meets to look at the evidence and make a decision about every six weeks. Every three months, it publishes the Monetary Policy Report, which sets out the economic analysis that it uses to make its interest rate decisions.
The MPC will announce its next decision on interest rates on Thursday 7 November 2024.
Why was inflation so high?
Three large economic shocks caused inflation to rise.
The first was the coronavirus pandemic. There was a large shortage of products and services, then as lockdowns eased there was suddenly huge demand for them. This pushed up prices.
We knew that wouldn’t last long. But then came the second shock: Russia’s invasion of Ukraine had a huge impact on energy and food prices.
For example, the war caused the supply of gas from Russia to drop significantly and gas prices rose as a result. That pushed up inflation because households consume energy directly (domestic gas and electricity supplies), and because higher energy costs make it more expensive for businesses to produce other goods and services.
The third shock was a shortage of workers available in the UK. Thousands dropped out of the workforce after the pandemic, which raised the cost of hiring. So, some businesses put up their prices to cover those costs.
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There are two main types.
One is known as ‘cost-push’ inflation. This occurs when there is a fall in supply of a product or service, raising the cost of production and therefore the price.
The fall in Russian gas supply after its invasion of Ukraine is a good example of this.
The other is ‘demand-pull’ inflation, which is when there is an increase in the demand for something relative to its supply. For example, too much money in the economy can lead to higher demand for goods and services than there are available, which raises prices and inflation.
Recent high inflation in the UK was driven primarily by higher costs. Covid-induced supply shortages, the invasion of Ukraine and lack of workers post pandemic all led to ‘cost-push’ inflation.
As interest rates influence the amount of spending in the economy, higher ones can neither stop these things from happening nor immediately prevent their effects.
Regardless of the cause, interest rates can help reduce the impact on inflation. By reducing the amount of demand in the economy, they can make it less likely that higher costs lead to higher prices. It can help to reduce any ‘second round’ effects of these shocks, eg when higher prices lead to higher wages, which lead to even higher prices and so on.
Why is the inflation target 2%?
The government has set us this target, which is similar to that of many other countries.
It is low enough to keep price rises small but high enough to avoid the problem of deflation – which is when overall prices fall, and businesses make less money and begin to cut costs by reducing wages or staff numbers.
Since 1997, inflation has at times risen above our 2% target and at other times fallen below. But we have always brought it back. Average inflation between 1997 and 2021 was 2%.
