This week we look at the relationship between inflation and the Bank of England (BoE) Bank Rate since 2005. It is generally expected for the BoE to raise Bank Rate if inflation reaches sustainable levels of above the Bank's 2% target. Higher Bank Rate will then in theory lead to a decline in inflation and stop the economy from "overheating".
The chart shows that in the aftermath of the Global Financial Crisis the BoE kept interest rates low despite inflation peaking at 4.5% in 2011 as the economy was recovering from the recession. However, in 2017 and 2018, Bank Rate was raised in response to above-target inflation.
The Bank of England has taken a more hawkish stance at its most recent meeting, stating that “some modest tightening of monetary policy is likely to be necessary over the next two years to keep inflation under control.” The comments come as inflation reached 2.5% in June before easing back to 2% in July, leading the Bank to revise up its inflation forecast to a peak of 4% this year.
However, policymakers believe the spike in inflation is transitory and that it will fall back to below the 2% target rate by the end of 2023. Markets now anticipate the first rise in Bank Rate in mid-2022. However, any increases will be modest and some independent forecasters such as Capital Economics don’t see any rate rises until 2023.