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Can someone help me understand how putting up interest rates will curb inflation?
The current high inflation seems to be due to cost of essential items such as energy and food its shooting up because of demand/ cost of supply? Is that right?
So how does increasing interest rates, reducing the amount homeowners have (if on STV mortgages) help with that situation?
is it by making stuff more expensive / having less disable income it will mean people use less and therefore demand reduce and costs go down?
So BoE is looking for us all to feel the pinch and buy less food / turn the heating down?
I am off the mark? Trying to understand why this is seen as a good thing to do (especially now)
is it by making stuff more expensive / having less disable income it will mean people use less and therefore demand reduce and costs go down?
Basically, yes. Also, if interest rates go up, savings rates go up, so people save rather than spend, reducing demand.
If you want learn a bit more watch this explanation by Ray Dalio.
Borrowing is disincentivised too which indirectly reduces spending and thus demand (all thing being equal).
Also, if interest rates go up, savings rates go up, so people save rather than spend
and also manage with the stuff they have, rather than borrow to buy more.
What I find difficult to understand is why 0.25% makes any difference to behaviour.
It is a signal/nudge. Making small changes helps you measure the impact they make. Like steering an oil tanker or Mr Bobby.
Encourages people and businesses not to spend money but to save it and/or service existing debts first.the reason for the very small increase is to signal a general direction to everyone before making significant changes.
It's not necessarily scientific in that there are different idealogical approaches around the world to this. Japan for example had or may still have negative central bank interest rates which is designed to push people and businesses to spend/invest money rather than hoarde, but it hasn't necessarily worked.
What I can't understand is how increasing interest rates to 0.25% will make any meaningful difference.
Surely interest rates would have to go up by a few percent to curb inflation, no?
Trouble with doing that is you can totally tank the economy as people and businesses can’t survive their debt. Even sticking rates to 1% would me an awful lot of people unable to afford their mortgages, particularly with household budgets so squeezed at the moment.
But, rates are likely to increase slowly over the next 24 months still further. I’m just glad I managed to get a stinking 7 year fixed rate on my remortgage…
What I can’t understand is how increasing interest rates to 0.25% will make any meaningful difference.
Surely interest rates would have to go up by a few percent to curb inflation, no?
It sends a signal to the markets that the trend is upwards which affects their behaviour in macro terms eg banks withdraw lower rate mortgage offers etc - this then changes what financial offers are availble to the man in the street etc, thus influencing their behaviour.
The idea is to specifically avoid any sudden jumps which can shock the economy, the idea is to give it subtle nudges in a new direction to bring about a change over time.
Even sticking rates to 1% would me an awful lot of people unable to afford their mortgages, particularly with household budgets so squeezed at the moment.
Well, the FCA has mandated, over the last few years, that all banks and building societies stress test all new loans with a higher interest rate to specifically avoid the scenario where people are so finely balanced that a 1% rise in rates would cause a default.
https://www.fca.org.uk/firms/fpc-mortgage-market-recommendation
The FPC’s ‘interest rate stress test’ Recommendation builds on our rules and specifies that lenders should assess whether borrowers could still afford their mortgage if, at any point over the first five years of the loan, mortgage rates were to be 3 percentage points higher than the contractual reversion rate.
@footflaps, yes I am aware of the FCA guidance (it’s my job to know these things 🙂 ) but there will be many mortgagees are right on the edge of affordability.
Don’t forget lots of people take on additional debt after taking out a mortgage and the cost of living has increased dramatically over the last 12 months so any stress tests on mortgages pre-pandemic are likely well out of date.
Add in that people will be dropping off their fixed rates and some will be unable to remortgage and will fall onto the lenders SVR which may already be 2-3% higher than their fixed and the fact that a 1% rise in base rate can lead to a higher than 1% rise in mortgage rates and there would be numbers of people in deep trouble.
Add to this the increased costs of unsecured lending (credit cards etc) and the impact would be substantial.
Don’t forget lots of people take on additional debt after taking out a mortgage and the cost of living has increased dramatically over the last 12 months so any stress tests on mortgages pre-pandemic are likely well out of date.
Yes, there will always be casualties, but the job of the BoE is to find the path of minimum disruption. Unchecked inflation raises the cost of living which also pushes people on the edge over it, so there is never a 'zero casuality' option. You just try and pick the best / least worst option.
Absolutely but @chainbreaker asked why they don’t stick the rates up by a few % points to curb inflation. I think we’re in agreement as to the reason they do not…
Also worth noting that interest rate only curb inflation caused by excess demand (too much cheap money). If the root cause is supply side (eg lack of workers as you've suddenly banned EU citizens from working here) then raising interest rates will make no difference (eg to wage inflation).
It's garbage. The BoE choose to use this one lever to drive the economy one way or another.
They ran out of road ages ago with it.
Pushing interest rates up will of course generally hurt the lower earners in society, especially with all the other struggles going on.
It's a ridiculous move with terrible timing from a seriously antiquated institution - that appears to only operate this one function.
Independent only to adjust interest rates.
The macro-economic model we have is screwed.
The issue with inflation comes from - just in time supply chain damaged by the pandemic and brexit. And Oil prices which are pretty much out of our control.
How the BoE think controlling liquidity with interest rates fixes the supply problem is beyond me.
Madness. But they have to be seen to be doing something.
https://twitter.com/RichardJMurphy/status/1471464383079399426?t=6KNHqeoTIyhC7SV8P1SwTw&s=19
Yes, there will always be casualties, but the job of the BoE is to find the path of minimum disruption
With basically one lever. Yeah right.
The Tories could manage the economy better with a range of options...
(But they're too dim or ignorant to bother.)
If you think their approach to covid is shambolic then double that for running the economy.