Britain is currently one of the fastest growing economies currently in the EU, however in the midst of a state of hesitancy in Brexit, their economic growth is stifling. In the midst of preparations for Brexit to fully come to pass, the Bank of England has raised interest rates to .75 percent in August of 2018 in an article by the New York Times. This modification is a drastic change to their initial cut on rates to .25 percent in June 2016. This article examines the use of monetary action to increase interest rates as Britain prepares for Brexit and it’s impact on their inflation.
The introduction of a raise in interest rates, otherwise known as the cost of borrowing, may allow for the Bank of England to cut rates at an easier pace, should Brexit diminish parts of the British Economy. Their concern about the current state of inflation, which is at a reported 2.4 percent.
As of 2018, the target inflation percentage has been surpassed by 0.4 percent as their initial target was 2.0 percent. As a result, the Bank of England has raised interest rates to tend to moderate growth in the economy.
The diagram above illustrates the decrease in demand due to a rise in interest rates in UK. After a rise in interest rates, aggregate demand and supply will subsequently fall due to the higher cost of borrowing and disposable income. In due course, consumer spending will be restricted as higher interest rates will encourage consumers to borrow less. As output falls from Y1 to Y2, the price will fall from P1 to P2 thereafter, giving firms less incentive to produce goods and also lower the demand for workers. The decrease in aggregate demand, there will be risks of negative growth and recession due to the lower economic growth and flow of money in the overall economy. Interest Rates in Britain were once as low as .5 percent, consumers may be used to lower interest rates, and there may be a drastic change in the economy due to this change. With less money circulating in the economy, consumers will have less money to spend on goods and services, instigating producers and sellers to heighten costs and thus causing a fall in aggregate demand. In addition, consumers will invest less.
This diagram illustrates the cost-push inflation influenced by the rising interest rates. This occurs because when costs to produce and sell increase, firms respond by increasing their own prices. As stated in the article, the price of goods and services are increasing due to inflation according to the Bank of England, therefor their rise in interest rates is in effort to slow down the inflation. As suggested by the quantity theory of money, whereby the demand/supply control inflation because of how the value of money can decrease and money supply grows. Higher rates will subsequently be inclined to reduce inflation which is the initial goal of the Bank of England. As a result businesses can protect their own profit margins by which their revenue can surpass their costs.
In conclusion, the imposition of higher interest rates by the Central Bank in August 2018 to combat inflation has worked to improve the economy, however it is not conducive to the presence of Brexit, leading to the likelihood that this has stifled the economy more than it will improve. Although inflation is not by all means a drawback for the economy, the impact on consumers and sellers may be hindering the circulation of money. Britain bears the uncertainty of Brexit and weak growth. The British Economy has weakened since the announcement, and limiting consumer spending puts stores at risk, influencing negative externalities to impact the community. Consumers may find that they can’t afford mortgages and loans. Even in the face of hesitancy, the Central Bank is taking monetary action on interest rates.