How does raising interest rates combat inflation? ‘Deeply worrying’ | Personal Finance | Finance


is currently at its highest rate in 40 years, with millions of Brits struggling to get by due to high costs and stagnant wages. The Office for National Statistics confirmed the rate had edged up to 9.1 percent in the year to May, from 9 percent in April, spelling even more misery for consumers and businesses.

Fuel and energy prices are the biggest drivers of skyrocketing inflation, but food and household goods prices have also risen this year.

The Bank of England has warned the pain is far from over, with further increases likely to take the rate as high as 11 percent in 2022.

In response, the Bank of England has incrementally been raising interest rates since late in 2021, as the cost of living crisis took hold.

The rate had previously been at its lowest ever, 0.1 percent, due to the coronavirus pandemic.

READ MORE: Gregg Wallace finds how families’ budgets are being gobbled up

When rates are low, inflation tends to rise, and when interest rates are high, inflation tends to fall.

Theoretically, raising interest rates puts people off borrowing money, meaning consumers and businesses will spend less and thus the high demand for products naturally falls.

But this isn’t necessarily foolproof. Stagflation is the term used for an economy that has high prices and stagnant wages, meaning the purchasing power of your pay is eroded.

Stagflation is an unwelcome term among economists and is extremely detrimental to household finances, and the crisis puts the Bank of England in a particularly precarious position when it comes to tackling the issue.

Federation of Small Businesses (FSB) Policy and Advocacy Chair Tina McKenzie said: “The Bank of England recently used the word stagflation in connection to the current economic crisis, which is noteworthy and deeply worrying.

“This is a scary moment. It’s hard to overstate how devastating the current spiralling inflation levels are, for businesses and consumers alike, and the longer the situation goes on, the more the damage compounds.

“The Bank is required to try and rein inflation in, although there are question marks over how much it can actually do, given that many of the factors behind inflation, from war in Ukraine to oil prices, are outside its control.”

Ms McKenzie continued: “The Government needs to act now. A further reduction in fuel duty, or even a cut in fuel VAT, would help ease the pain.

“More widely, a cut in VAT would give the economy a real boost, and would be a lifeline to countless struggling businesses. At the very least, cutting VAT on energy would offer real help.”

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