Economy tracker: Interest rates

UK Economy

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The Bank of England's Monetary Policy Committee (MPC) kept interest rates at the record-low level of 0.5% at its meeting in June.

It also decided to keep its programme of quantitative easing at £325bn. Through this the Bank injects new money into the economy with the aim of trying to lower borrowing costs, boosting spending and stimulating growth.

Understanding monetary policy

The Monetary Policy Committee meets every month and its main task, set by the government, is to keep inflation at 2%

It is looking at what it expects inflation to be in about two years' time, as it assumes changes in rates will take that long to work
It sets Bank rate, which is the percentage it charges on loans it makes to banks and other financial institutions. That influences what the banks and building societies charge for loans and mortgages and the returns they pay to savers

If it thinks inflation is likely to undershoot the 2% target, the Bank will cut interest rates, stimulating borrowing, spending and job creation

If it thinks inflation is likely to be higher than 2%, it will raise interest rates, suppressing consumer demand and business investment

Recently it has brought in another policy measure, quantitative easing, which it calls its Asset Purchase Facility
The bank creates new money and injects it into the economy to try to boost spending. It does this by buying assets from financial firms, including High Street banks, insurance companies and pension funds
One way QE might stimulate demand is if these companies spend the money they receive for their assets. If they buy shares, for example, the companies they invest in could decide to buy new equipment, helping them grow and even take on new staff
Under QE, the Bank of England usually buys gilts. These are bonds, a form of IOU issued by governments to borrow money. The extra demand for these could have the eventual effect of bringing down the cost of borrowing more widely - helping businesses and households
In order to change Bank rate or the amount of QE, a majority of the MPC's nine members needs to vote for it. The minutes of each meeting are published two weeks afterwards

Background

FALLING RATES

8 October 2008: 4.5%
6 November 2008: 3.0%
4 December 2008: 2.0%
8 January 2009: 1.5%
5 February 2009: 1.0%
5 March 2009: 0.5%

Q&A: Quantitative easing

When the global financial crisis broke in 2008, interest rates were at 5%.

The Bank of England made its first cut just a few weeks after the bankruptcy of US bank Lehman Brothers. More cuts were made as the financial system came close to collapse and a global recession took hold.

At the beginning of 2009 in the UK, unemployment was rising sharply, business and consumer confidence was severely depressed and banks were holding onto their funds.

The succession of cuts in the cost of borrowing had brought rates down to a historic low, but, with the economy still in recession, more still needed to be done to try to kick-start the recovery.

First, with the permission of the Treasury, the Bank of England creates lots of money. It does this by just crediting its own bank account.

The Bank of England wants to use that cash to increase spending and boost the economy so it spends it, mainly on buying government bonds from financial firms such as banks, insurance companies and pension funds.

The Bank buying bonds makes them more expensive, so they are a less attractive investment. That means companies that have sold bonds may use the proceeds to invest in other companies or lend to individuals.

If banks, pension funds and insurance companies are more enthusiastic about lending to companies and individuals, the interest rates they charge should fall, so more money is spent and the economy is boosted.

Theoretically, when the economy has recovered, the Bank of England sells the bonds it has bought and destroys the cash it receives. That means in the long term there has been no extra cash created.

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So in March 2009, along with a last cut in rates to 0.5%, the Bank also introduced a programme of quantitative easing.

It initially injected £75bn of new money into the economy, but this has since been expanded in steps up to the current level of £325bn.

When it made its most recent increase in February 2012, the Bank explained that this was necessary because of the slowing pace of recovery at the end of last year and concerns about the fate of some of the UK's important trade partners in the eurozone.

It feared that without this additional stimulus, inflation would undershoot that all-important 2% target.

Figures used in chart above: Bank Rate 1694-1972, Min Lending Rate 1972-1981, Min Band 1 Dealing Rate 1981-1996, Repo Rate 1997-2005, Official Bank Rate, 2006 onwards