It was very much expected for an increase in interest rate by the Central banks of all the countries. But the only Question till now was when will it start.
Finally, the Bank of England has increased the interest rate to 0.25% from 0.1% to tackle rising prices.
Let us understand first, What is the Interest rate?
In simple words, The rate at which return is paid by the borrower to compensate the lender for a loss in value of money over a period of time.
Why is it necessary to increase the Interest rate?
The interest rate has a major impact on the economy. To maintain the liquidity position in the economy, interest rates are hiked or reduced.
The interest rate has been hiked to control the inflation in the economy. A higher interest rate will lead to a decrease in liquidity in the economy and savings will increase. The borrower will be less interested to borrow funds at a high-interest rate that will control the demand in the economy.
Why does the Bank Of England Hike the Interest rate?
Uk Consumer price Inflation has surged to 5.1% in November, it is the highest rate from the last 20-30 years and it is expected to rise further in interest rate to deal with the inflation.
Worldwide during the pandemic, central banks of almost every country have maintained the interest rate static to give more liquidity in the economy. But the growth of the economy hasn’t gone as expected which leads to an increase in inflation. The increase in rate will affect the financial position of households and also the firms with higher borrowing costs.
The Omicron variant is spreading fastly which brings more concern for the growth of the economy.
If this virus spreads then we can expect the highest inflation rate in history. The Bank of England has expected to rise in inflation to 6% by April 2022. The European central bank also cuts the growth rate of the economy.
But one more fact is that if omicron spreads faster and inflation is so high it is interesting to see how the central bank deals with that situation, increase in omicron will again slow the economy and again liquidity will be needed in the economy. If it happens then It will be really the worst situation but the central bank has to be ready about this situation.
Explaining the rate increase, the Bank said successive waves of Covid had less impact on GDP as households and businesses gradually adapted to life with the pandemic. Although there was uncertainty this time around, it said Omicron could fuel persistently high levels of inflation if it led to sustained disruption to supply chains through factory closers and bottlenecks at ports.
The above graph (Source: Bank of England) shows the interest rate over the years.
Despite the rate rise on Thursday, 0.25% is still a lower interest rate than before the pandemic, when borrowing costs were set at 0.75% before the first wave spread to Britain in early 2020.