Friday, August 5, 2022

How does interest rate affect inflation?

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Interest rates are expected to rise on Thursday as the Bank of England struggles to contain rising inflation.

The baseline inflation rate is already at its highest level in 13 years after the bank raised it to 1 percent.

On May 6, the institution’s Monetary Policy Committee voted to raise the base rate from 0.75 percent to 1 percent, the fourth consecutive time the panel has voted to raise interest rates.

The committee is now expected to hike interest rates even further on Thursday, possibly to 1.25 percent.

Governor Andrew Bailey had warned ahead of May’s announcement that the BoE would have to walk a “very fine line” between cooling inflation and triggering a recession.

Consumer confidence fell last month and retail sales came in lower than expected on rising energy bills, food prices and fuel costs.

Here’s a quick and easy guide to how the latest interest rate change will affect you.

An interest rate is a measure of what the cost of borrowing is, or the return of saving.

When you borrow money, usually from a bank, the interest rate on that money is the amount you are charged for borrowing it.

A fee is charged on the total amount of the loan and displayed as a percentage of the total amount.

Higher percentages mean you have to pay the lender more money to borrow the money.

When you save money in a bank account, the interest rate on that money is the amount that accrues to you on top of your savings. Banks pay you a percentage of your total savings, usually at the end of the year.

Low interest rates are used to discourage people from hoarding their money in savings accounts. High interest rates encourage saving because people get a better return on the money they put away.

This, in turn, affects the price of goods.

When interest rates are low, people may spend more, which can cause retailers to increase the price of goods.

When interest rates are high, demand could fall as people put more money into their savings pots. This should theoretically lower the prices of goods and services.

However, rising prices are not a direct consequence of changes in interest rates. Other things, including the money supply and the underlying costs, affect prices and cause inflation.

Interest rates can only help control inflation.

Changes in the BoE base rate, which is the rate at which banks borrow from the bank, affect the interest rates that high street banks then charge their mortgagees.

The changes in interest rates will affect everyone who has savings and everyone who borrows money from the banks, for example in the form of a mortgage.

It will also have wider implications for the economy. By raising interest rates, the BoE hopes to dampen rising inflation and help with the cost-of-living crisis.

Nonetheless, inflation is expected to rise further in the near future – with a tip to over ten percent.

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