Why does the Bank of England change interest rates?

  • Published
Bank of EnglandImage source, Getty Images

The Bank of England has increased rates by 0.75 percentage points to 3%, the biggest hike in more than three decades.

Interest rates have been rising since December in an effort to curb inflation, the rate at which prices are going up.

What is the Bank of England?

The Bank of England is the UK's central bank. It is independent of the government.

Its main job is to manage the overall state of the economy, and the stability of the financial system.

Why does the Bank of England change interest rates?

One of the Bank's main duties is to try to keep the cost of living stable.

It has a target to keep inflation - the official measure of how quickly prices are rising - at 2%, but prices are currently rising at about five times that level.

The Bank's traditional response to tackle rising inflation is to increase the UK's official interest rate, which influences the saving and borrowing rates charged by high street banks.

In November, the Bank increased rates by 0.75 percentage point to 3%, the highest level since 2008, when the UK banking system faced collapse.

It followed an increase of 0.5 percentage points to 2.25% at its previous meeting in September. At the time, it warned that further rises were likely.

Putting up interest rates can mean people are more likely to save money, and less likely to borrow money. In theory this means they have less money to spend so will buy fewer things, which should help stop prices rising as quickly.

Alternatively, if the Bank cuts interest rates, there's less incentive to save money and borrowing becomes cheaper. This can encourage people to go out and spend more, boosting the economy.

How does the Bank of England change interest rates?

After previously meeting every month to decide interest rate policy, the Bank's monetary policy committee (MPC) now convenes eight times a year to set rates.

After a series of preliminary meetings, the committee's nine members vote on whether to increase, reduce or hold interest rates, and their collective decision is published at noon.

Minutes of the meeting where the decision was taken are also published.

The next announcement about interest rates will be on 15 December.

Four times a year the Bank also publishes a Monetary Policy Report which sets out the economic analysis and inflation projections that the MPC uses to make its interest rate decisions.

Image source, Reuters
Image caption,
Andrew Bailey has been governor of the Bank of England since 2019

What else does the Bank do?

The Bank of England also buys and sells government bonds.

Bonds are a bit like an "I owe you" from the government, which uses them to raise money to help meet its spending commitments.

In the period from the 2009 financial crisis until 2021, the Bank of England bought £875bn of government bonds. This was done through a process called quantitative easing which was designed to reduce overall government borrowing costs, lower interest rates and stimulate spending in the economy.

The Bank announced an emergency bond-buying programme to try to stabilise the economy after September's mini-budget caused turmoil on financial markets.

This intervention has now ended, and the Bank is now going ahead with a plan first announced in August to sell off some of the government bonds it holds.

What are the Bank's other responsibilities?

The Bank also:

  • produces banknotes and oversees credit and debit card payments
  • regulates banks and building societies
  • monitors risks in the UK financial system and acts to reduce them, like lending to banks if they need it. It shares responsibility for this with the Treasury and the financial regulator, the Financial Conduct Authority
  • stores the UK's gold reserves - 400,000 bars worth more than £200bn - as well as those of other central banks
Image source, Central Press/Getty Images
Image caption,
Streets around the Bank's headquarters were destroyed during the Blitz

Who is in charge of the Bank of England?

Andrew Bailey took over as governor in 2019, having previously worked at the Bank for more than 30 years.

He was the Bank's chief cashier from January 2004 until April 2011, which meant his signature appeared on billions of UK banknotes.

As well as being responsible for overseeing the Bank's main responsibilities, the governor also chairs three important committees that help it work towards its targets: the Monetary Policy Committee, the Financial Policy Committee and the Prudential Regulation Authority.