To not understand why BoE is raising interest rates

[loveisagirlnameddaisy]

I understand the principle of putting interest rates up to curb inflation. But when inflation is being caused by global price increases caused by a pandemic AND a war in Europe - AND that many of the price increases are for basic goods e.g. energy and food, not luxury goods - what is the rationale?

Usually it's to slow down borrowing for consumers purchasing high-ticket items and to curb price increases by businesses which have high demand for something. But does high demand for food really count? What are we supposed to do? Not eat? Doesn't the BoE have a more sophisticated and targeted solution to deal with inflation. Raising interest rates just because that's what they've always done seems very short sighted and rather a blunt instrument. What am I missing?

I thought it was to support the currency but if they raise rates and then talk down the prospect of future rises surely that defeats the point of an increase? Pound is down almost 3% today against the dollar.

Completely agree with you OP. I heard on the radio that the BoE needs to put up interest rates to curb wage inflation, but if the reason (some) wages are going up is a shortage of labour and an increase in the costs of basic necessities like food and heating, I'm not sure who that really helps?! Surely using interest rates to bring down inflation doesn't work when the inflation is caused by the rising cost of basic necessities that people have no option not to buy?

You’re right OP. It’s an economic policy from the past, 🤷‍♀️

Raising interest rates doesn't much help to combat inflation when the cost of necesities/fuel/energy is driving the increase in inflation, but the trouble is the BoE has a very limited number of tools to combat inflation.

They're raising interest rates, because that's pretty much the only weapon in their arsenal. It will "help" to slow down borrowing/spending on luxuries, so I expect it will work to massage the numbers a bit, but it won't make the cost of living appreciably better for those feeling the pinch.

You’re right OP. It’s an economic policy from the past

Don’t leave it there. Suggest a more effective alternative economic policy from the present.

I think the point is to strengthen the pound, because if investors can get a better interest rate in the UK they are more likely to invest. They need to buy pounds to do that and therefore demand for the pound will increase, therefore increasing the value of the pound. That helps to bring prices of imported goods down. The issue is that other countries, Eg. the US, are also increasing interest rates, so that is already dampening demand for the pound before they've even started.

That does make more sense if that is indeed what the BoE intends to happen. Ive never seen it reported in the news that way. Would be much more helpful if it were!

It's hard to know the mind of the market exactly.

But I would speculate it is due to the fact that the US are being very hawkish on raising rates to combat inflation, and indicating that they will do whatever it takes.

Whereas the BOE are basically saying that the market inflation predictions are worse than what they estimate. Which kind of indicates that the BOE thinks there are going to be less rate rises necessary than the market. So that causes a mini sell off.

This wouldn't be so bad if the BOE was actually any good at forecasting inflation. In fact it is absolutely rubbish at inflation forecasting. Which probably explains some of the reason why we are where we are.

The idea behind interest rates is to stop people spending money. That won't work this time around because the inflation is not caused by people spending money.

The obvious solution surely is to levy a higher rate of VAT on non-essential/luxury items. Unlike interest rate rises, which affect the poorest more than the richest, a higher rate of VAT on products as they become more unnecessary or more frivolous would curb inflation naturally.

For example, food could continue at the current rate of VAT because everyone needs to eat. Alcohol could maybe go up to 25% VAT, and I say that as a functioning alcoholic so would be more affected by this than most. But higher end stuff, say a bottle of wine that costs over £8, should be charged 40% VAT, then add 10% for every increase of £10. So if someone wants to buy a £200 (today) bottle of wine they can, but they'll be paying a huge amount in VAT (more than the rest of the price altogether).

Likewise a basic car that costs under £10,000 could have a 30% VAT charge, then for every £5K increase the VAT goes up by 10%. If someone wants to buy a 250K Rolls Royce they can, but they'll now be spending £925,000 instead because there will be a huge amount of VAT.

Alot of our inflation is from money printing during since 08 and especially recently since COVID. Yes, this has been made worse by global events, but this has led to asset bubbles in housing and markets. The BOE should have been normalising rates years ago, now they are playing catch-up. We have to get used to not having free money and saving instead of borrowing. It's going to be very hard, but rampant inflation is really much worse than a recession in the long run.

Funnily enough the only thing I think Bailey was going on about in the press conference was the war in Ukraine.

Look everyone - over there !

But inflation will fall below 2% in the next year, by the BoE own calculations. Because the inflation is driven by strange things- energy and goods supply- both of which are now settling. This rate rise is helping us dig into a deep recession- which will be a disaster for everyone.