The BoE is in charge of keeping the UK’s financial system secure and assisting with keeping a steady money supply. The bank does a lot in affecting the UK’s economic growth because it holds the government’s gold reserves and is the final lender to the country.
Macroeconomic direction through monetary policy is needed to meet each of these goals. By making the behavior of consumers and corporations dependent on the monetary instruments they employ, interest rates and other monetary tools can be used to affect how much people and businesses spend on their purchases.
Monetary policy has as its principal purpose to contain inflation and prevent recessions.
Monetary policy targets
1. The BoE is tasked with keeping inflation under control, and the central bank aims to achieve this by instituting policies that keep prices within small margins of 2%. For successful long-term investing, keeping inflation low is important.
2. Stable economic growth: Monetary policy involves a long-term growth rate and low unemployment, both of which are served by ensuring stable GDP growth through the use of the monetary policy.
Implementing monetary policy in the UK
To guarantee that the rates of interest on loans and bonds are on par with the target of the BoE, the MPC is given the liberty to make decisions free of governmental influence. Even though this will put the MPC at odds with the government’s wish to maintain low inflation, the MPC will probably still collaborate with this.
The BoE can increase or reduce interest rates on their own, as well as making decisions over whether to raise or lower them. Commercial banks in the UK must borrow money from the BoE at the base bank interest rate, which is essentially equivalent to what they may obtain on the open market.
Assessing the impact of interest rate changes on the broader economy is fairly complex, given the fluctuations in rates periodically. When deciding how much interest a borrower pays, there are various elements to consider.
The borrower’s interest rate depends on the amount of money they borrow, the time frame in which they borrow it, and numerous other details. Although there might be difficulty collecting data on how interest rate shifts will impact the economy, a search on various banking institutions’ interest rates can assist in understanding the macroeconomy.
The MPC
Every so often, a group of economic specialists that make up the Monetary Policy Committee meets to deliberate on monetary policy.
In the UK, it is the BoE alone that has control over monetary policy. The MPC will do all it takes to make sure inflation stays at 2 percent. The disadvantage to keeping the inflation rate lower than the objective is similar to the problem with permitting it to be beyond the target. In either case, it means bad news for the economic stability of the UK. Because of this, lower inflation means just as much trouble for the BoE as having higher inflation.
In monthly meetings, MPC members discuss changes to the policies and then make rate decisions that support those changes.
To better understand the economy, the BoE studies macro trends. They focus on things like the unemployment rate, consumer spending habits, the surplus in the economy, the exchange rate index, the price of homes, and GDP growth.
The BoE depends on data like these to assess if inflation will rise or fall. If the inflation has spiked and there is a consensus that shows optimistic economic forecasts, the BoE will raise interest rates. If they think GDP growth will slow down and inflation will decrease, they are likely to slash interest rates.
Lowering interest rates when they’re already below acceptable levels will lead to inflation, but stimulating demand when there is already enough employment could lead to overexertion, with unmet demand.
Quantitative easing
In the wake of the 2008-2009 global recession, the BoE started using Quantitative easing (QE) as an alternate monetary strategy. This is accomplished by generating new cash by, for example, investment in Treasury bonds. When businesses are allowed to buy products that are difficult to sell, it is thought that this will increase the amount of money in circulation and help avert a deflationary spiral.
It is assumed that by purchasing illiquid items, the money supply will rise, and deflation will be averted.
Loose vs. tight monetary policies
There are times when the BoE may need to loosen its monetary policy. We’ll see this reaction when weak or decreasing GDP growth happens alongside lower-than-expected inflation rates, as estimated by the BoE. Because of these conditions, many experts often expect the BoE to reduce base bank rates.
Many believe that low-interest rates have a better chance of helping the economy grow. The borrowing costs will be lower as a result of decreased interest rates. Another perk that comes with this is a boost to consumption because people paying off their bank loans have a reduced burden, which allows them to spend the extra cash on other things. This effectively increases the amount of money circulating in the UK economy.
Conversely, there may be times when there’s a need to tighten things up. In such instances, the BoE raises interest rates to control inflation and protect the economy from heating up when it expects inflation to overshoot its 2% target. When interest rates go up, it costs more to borrow money. Thus consumers spend less, and corporations invest less. There is also a reduction in inflation.
Interest rates and inflation
Why are interest rates so low, and why are they still being kept above zero?
BoE has identified the following two factors as requiring an inflation target above zero.
1. Interest rates can sometimes fall below zero, depending on circumstances.
When demand is low, interest rates may sometimes sink into negative numbers.
True interest rates are given by the nominal rate, which is the actual rate. Banks are able to establish their rates wherever they like but are unable to offer negative interest rates on loans.
2. If inflation is zero, the real interest rate can’t be negative since the real interest rate must equal the nominal interest rate in this situation. It’s possible that the BoE can put negative interest rates in action during a severe recession. They can do this by instituting a positive inflation target.
UK interest rates and the economy
Interest rates and inflation are strongly correlated. Interest rates effects are targeted at achieving specific future inflation targets. The fact that UK inflation takes two years to play out means that the BoE must forecast what will happen in the economy two years in advance!
In summary
The BoE has a big role to play in not only defining the UK monetary policy and bank rates but also influencing the UK’s economy. Considering that the UK is among the world’s seven largest economies, the BoE’s decisions affect many other economies as well. Investors interested in investing in the UK or exporting to the nation should integrate the bank’s decisions in their strategies.
