We have recently witnessed inflationary pressures that have not been seen in the UK for over 30 years and of course the Bank of England were forced to respond but did they do the right thing? 

The war in Ukraine caused an economic shock which was felt worldwide through higher energy, food and commodity prices and thus unprecedented levels of inflation which reached a height of 11.1% in the UK.  

The rising costs of raw materials then led to businesses pushing up prices for consumers, which then drove a rise in wages with both of these causing inflation to spiral – something the Bank of England were forced to act upon.  

As a result, the Bank of England embarked on an aggressive scheme of tightening monetary policy which included 14 consecutive rate rises from the historic lows of 0.1% in 2020 up to a startling 5.25%. 

This was a frightening prospect for many borrowers – mortgage holders in particular – who faced increased pressure at the time that all their other costs were rising yet mortgages were becoming up to a third of people’s income.  

Now the Bank of England will tell you that these high rates were absolutely necessary to prevent inflation becoming “persistent” however they “didn’t aim to make anyone worse off” (or at least that’s what they told me). 

But was this really necessary? I think not.  

Firstly, the Bank of England were most certainly aiming to make people worse off, that is the point of restrictive monetary policy: to reduce spending in the economy through making it more expensive to borrow. This will always make people worse off, even if they don’t actively set out to make people poorer (which they don’t), effective restrictive monetary policy should make people worse off otherwise it hasn’t worked.  

The second issue I have with the Bank is that I believe the rates were too high to deal with the inflation we faced and there are two reasons for my theory: 1, the Bank of England were too slow to react and 2, the cost of living crisis actively led to a drop in spending so did the Bank need to be so aggressive. 

Let’s tackle the first point, were the Bank of England too slow to react? Well their own Chief Economist, Huw Pill, all but admitted they were late to the inflationary party as he said the Bank were “surprised” at the impact of Russia invading Ukraine and it was a “profound shock”. 

Now I’m no expert in geopolitics and can accept that it was a surprise that Russia decided to mount an attack on Ukraine however surely it would be a logical step to assume that this would have an economic consequence (especially with Russia’s major role in the world energy market) and begin to slowly increase rates preemptively.  

However, to be fair to the BoE, most of the world’s central banks missed this opportunity and with the wonders of hindsight it seems obvious now that a rate rise was needed but I still think they were too late and thus had to raise rates higher partly to achieved their desired objective and partly to look like they were actually doing something rather than being the sleepy old lady of Threadneedle Street.  

Moving onto my second reason for why the base rate shouldn’t have been risen so high: the rise in prices across the board meant consumers were already cutting spending and didn’t need any extra pressure heaped onto them by the Bank of England.  

To understand this point a tiny bit of economics is required so bear with me. Inflation is the rate at which prices rise and has two key causes: cost-push and demand-pull. Cost-push inflation is where the price of a key good rises (such as energy or food) and customers have few alternatives so prices rise (which is what we have) whereas demand-pull is where demand outstrips supply (possibly due to falling unemployment or rising GDP) and so prices rise.  

Uncontrolled inflation (over or below the Bank of England’s 2% target) is highly problematic and so the Bank changes the base rate which affects the supply of money in the economy. In times of high inflation, this rate is risen to make borrowings more expensive and incentive saving which reduces demand and thus reduces inflation – do you see the problem? The Bank of England is using policies which affect demand to (try to) fix a supply issue and at that a supply issue caused by a totally external factor.  

As such, the 5.25% rate hasn’t had a massive impact on inflation and it is still above the 2% target despite prolonged periods of high rates suggesting it might not be working particularly well.  

Another reason why the rate rise wasn’t particularly effective is that energy bills are one of a household’s largest expenses (especially for the poorest members of society) and thus a considerable rise in this will cause households to cut back naturally without the Bank steaming in with heavy-handed interventions.  

With my personal finance hat on, the rate rises have been a terrible policy as they have put the UK’s thousands of mortgage holders under mostly undue pressure and banks haven’t passed on savings rates as much as they should have meaning that our savers haven’t reaped the rewards they should have (another reason why the rate rise hasn’t worked).  

So what does all this mean for the economy? Well, we have just officially entered a recession (two consecutive quarters of falling GDP) which is typically corrected by a fall in interest rates so we will have to keep an eye on what the Bank does next. Many consumers and businesses across the country are defaulting on their loans (most notably Asda) as a result of the high rates which is never a good sign so I’m predicting some rate cuts in the future…watch this space! 

I also put my theory to the Bank of England’s Chief Economist who remarked it was a “good observation” and proceeded to not give a straight answer to the question so I’ll let you infer what you like from that.  

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Do comment your thoughts below.