Kavan Choksi UK Discusses The Bank of England’s Function Of Setting Interest Rates

The Bank of England or BoE is the central bank of the United Kingdom. It is also one of the oldest central banks in the world. Kavan Choksi UK mentions that the BoE was established in 1694, and serves as a bank to both the government and the banking system of the country. It also is responsible for the overall stability of the financial system of the United Kingdom.

Kavan Choksi UK sheds light on the Bank of England’s function of setting interest rates.

The functions of the Bank of England are related to the pursuit of certain major objectives. These objectives include maintaining the value and integrity of the currency, seeking to ensure the competitiveness and effectiveness of the financial services of the United Kingdom, as well as maintaining the stability of its financial system.

The Bank of England or BoE can control money supply and liquidity, and sets the repo rate or the base rate. It basically is the interest rate at which commercial banks borrow from the BoE. Commercial banks often need to borrow money for the short term from the BoE. As a result, the repo rate of the BoE is quite important for commercial banks. In case the central bank does increase its repo rate, the commercial banks across the United Kingdom are also likely to increase their interest rates. However, it is imperative to understand that banks are not obliged to follow the Bank of England rate decisions. For instance, when the BoE cut interest rates to 0.5%, many mortgage companies did not cut their own interest rates. But overall, the base rate set by the BoE does determine all the main saving and borrowing rates in the economy.

The Monetary Policy Committee or MPC of the BoE meets each month to decide whether the interest rate must be changed or not. They have an inflation target of CPI – 2%+/-1, which basically means that BoE strives to keep the inflation close to 2%.  In case inflation increases above the target, then the BoE may choose to increase interest rates.

As Kavan Choksi UK says, higher interest rate essentially makes savings more attractive and increase the cost of borrowing. It helps lower consumer spending and investment, and may cut down the growth of aggregate demand. Hence, economic growth typically slows down, which ultimately helps reduce inflationary pressure. In case the inflation rate is below target, the BoE may cut interest rates in order to boost economic growth and spending.

 MPC uses economic variables and inflation forecasts to predict future inflation. Factors that influence the inflation forecasts of the BoE include:

• Consumer spending levels
• Investment levels
• Consumer confidence
• Wage rates, rising wages may cause both cost-push and demand-pull inflation.
• Commodity prices, rising oil prices may cause inflation
• Rate of economic growth compared to long-run trend rate

In addition to targeting inflation, the BoE also considers other aspects of the economy, including the impact of monetary policy on economic growth and unemployment. At times, inflation may go above target, but the BoE may feel that they should keep interest rates low.