Every country has one bank above all the others. The word for it is the central bank. In the UK it is the Bank of England. It sets one interest rate, and mortgage, loan and savings rates across the country follow it. From December 2021 to August 2023 it raised that rate from 0.1% to 5.25%.
The central bank raises its rate to slow price rises. A higher rate makes borrowing cost more. People and companies borrow less, so they spend less. Sellers find fewer buyers and stop putting prices up. The rate reaches shop prices only through spending, and the trip takes a year or more.
Bank rate, December 20210.1%
Bank rate, August 20235.25%
The Bank of England raised its rate from 0.1% to 5.25%. What is the FIRST thing a rate rise changes?
Wages rise to match.
Not yet. Backwards. Dearer borrowing is meant to cool spending. Cooler spending gives employers less reason to raise pay.
The cost of borrowing. Mortgages, loans and overdrafts get dearer.
Right. The rate is the price of borrowed money, and that is the only thing the central bank sets directly. Everything else it wants has to come from people borrowing less.
Prices in the shops fall.
Not yet. Prices are the last link in the chain, a year or more away. Even then they slow rather than fall. The rate reaches them only through people spending less.
Put the chain in order, from the rate rise to slower inflation.
Tap them in the order they happen, first to last. Each tap gets a number.
Right. Four links, and the bank holds only the first. The other three are millions of people deciding to spend less. That is why it takes a year or more, and why people have to spend less before prices slow.
A rate rise reacheshow much people want to buy
vsvs
It cannot reachhow much there is to buy
Demand on the left. Supply on the right. A drought is on the right.
A rate rise works on how much people want to buy. It does nothing to how much there is to buy. If a drought halves the wheat crop, a rate rise grows no wheat. It can only make people buy less bread. Wanting to buy is called demand. Having it to sell is called supply.
A made-up market. Set how much people want to buy, and how much there is to buy.
Price level (100 = normal)114
Amount actually sold70
How much people want to buy (demand): Low · How much there is to buy (supply): Short
Demand low, supply short. Prices sit at 114 and 70 units are sold.
Price level (100 = normal)80
Amount actually sold80
How much people want to buy (demand): Low · How much there is to buy (supply): Normal
Demand low, supply normal. Prices sit at 80 and 80 units are sold.
Price level (100 = normal)62
Amount actually sold80
How much people want to buy (demand): Low · How much there is to buy (supply): Plentiful
Demand low, supply plentiful. Prices sit at 62 and 80 units are sold.
Price level (100 = normal)143
Amount actually sold70
How much people want to buy (demand): Medium · How much there is to buy (supply): Short
Demand medium, supply short. Prices sit at 143 and 70 units are sold.
Price level (100 = normal)100
Amount actually sold100
How much people want to buy (demand): Medium · How much there is to buy (supply): Normal
Demand medium, supply normal. Prices sit at 100 and 100 units are sold.
Price level (100 = normal)77
Amount actually sold100
How much people want to buy (demand): Medium · How much there is to buy (supply): Plentiful
Demand medium, supply plentiful. Prices sit at 77 and 100 units are sold.
Price level (100 = normal)171
Amount actually sold70
How much people want to buy (demand): High · How much there is to buy (supply): Short
Demand high, supply short. Prices sit at 171 and 70 units are sold.
Price level (100 = normal)120
Amount actually sold100
How much people want to buy (demand): High · How much there is to buy (supply): Normal
Demand high, supply normal. Prices sit at 120 and 100 units are sold.
Price level (100 = normal)92
Amount actually sold120
How much people want to buy (demand): High · How much there is to buy (supply): Plentiful
Demand high, supply plentiful. Prices sit at 92 and 120 units are sold.
Price level (100 = normal)200
Amount actually sold70
How much people want to buy (demand): Very high · How much there is to buy (supply): Short
Demand very high, supply short. Prices sit at 200 and 70 units are sold.
Price level (100 = normal)140
Amount actually sold100
How much people want to buy (demand): Very high · How much there is to buy (supply): Normal
Demand very high, supply normal. Prices sit at 140 and 100 units are sold.
Price level (100 = normal)108
Amount actually sold130
How much people want to buy (demand): Very high · How much there is to buy (supply): Plentiful
Demand very high, supply plentiful. Prices sit at 108 and 130 units are sold.
Supply is SHORT, after a bad harvest. What does cutting demand do to prices?
Brings them down, but only by making people buy less of something there is already too little of.
Right. The price falls as demand falls, and the shelves are no fuller. A rate rise can only ever move the first control. It grows no wheat.
Nothing. A shortage is a shortage.
Not yet. Slide demand down with supply short and the price does fall. A rate can move a shortage's price. The problem is what that costs: people going without.
Fixes the shortage.
Not yet. Supply did not move. The only control a central bank has is demand, and pushing it down does not put a single extra unit on the shelf.
Move both controls.
Four prices rising in the same year. Tap the one a rate rise can reach.
Tap the part of the picture that answers it.
Which rise is made of people borrowing?
Gas, after a pipeline is cut40%
Second-hand cars, after cheap loans flood in25%
Wheat, after a drought30%
Shipping, after a canal is blocked50%
Second-hand cars, after cheap loans flood in
Right. This rise is made of borrowing. Make the loans dearer and fewer people buy, so the price falls. It is the one rise here that a rate can touch.
Gas, after a pipeline is cut
Not yet. This was the biggest cause of 2022's inflation, and nothing a rate can reach. Dearer mortgages do not reconnect a pipeline.
Wheat, after a drought
Not yet. A rate rise grows no wheat. It can make people buy less bread, which lowers the price by making them go without.
Shipping, after a canal is blocked
Not yet. The shortage is a canal. Dearer borrowing in one country does not clear it. It just means fewer people can afford what gets through.
Monthly payment at 1%£754
Monthly payment at 5%£1,169
A £200,000 mortgage paid off over 25 years.
A rate rise also moves money between people. A family whose mortgage rate can change pays more from next month. A saver with cash in the bank earns more from next month. A family on a deal fixed until 2029 feels nothing until 2029.
The rate rises from 1% to 5%. Who pays more, who earns more, and who is untouched this year?
One card at a time. Tap the pile it belongs to.
Card 1 of 6
A family on a mortgage whose rate can change
A saver with cash in the bank
A family on a mortgage fixed until 2029
A business living on its overdraft
A government about to borrow to cover this year's spending
A pensioner whose pension is a fixed monthly sum
A family on a mortgage whose rate can change → Pays more
Not yet. This family pays more. Their rate can change, so the rise reaches their monthly payment next month.
A saver with cash in the bank → Earns more
Not yet. The saver earns more. The bank pays interest on the cash, and the rate just went from 1% to 5%.
A family on a mortgage fixed until 2029 → Untouched this year
Not yet. This family is untouched this year. Their deal holds 1% until 2029, and the new rate arrives only when it ends.
A business living on its overdraft → Pays more
Not yet. The business pays more. An overdraft's rate changes at once, so the extra cost lands on the next statement.
A government about to borrow to cover this year's spending → Pays more
Not yet. The government pays more. New borrowing is done at the new rate, and 5% costs more than 1%.
A pensioner whose pension is a fixed monthly sum → Untouched this year
Not yet. The pensioner is untouched this year. A fixed monthly sum has no rate in it, so a rate rise cannot reach it.
Borrowers whose rate can changepay more
vsvs
Saversearn more
vsvs
Fixed dealsuntouched, until they end
Right. A rate rise moves money from borrowers to savers. It reaches each borrower when their loan's rate next changes. A fixed deal holds the old rate until the day it ends, and then the new rate arrives all at once.
Pay rises asked for when people expect 2% inflation3%
Pay rises asked for when people expect 10% inflation11%
Made-up numbers.
The central bank does one more thing. It says out loud that it wants inflation at 2%, and it says so again and again. That matters because people set next year's prices and pay on what they EXPECT. If they expect 2%, they ask for about 2%. If they expect 10%, they ask for 10%.
Gas200%
Everything else8%
Rough price rises that year.
In 2022 the price gas companies pay for gas roughly tripled after a pipeline was cut, and central banks raised rates hard. What could the rate rises do about the gas price?
Bring the gas price back down.
Not yet. A rate opens no pipeline. Gas came down when new supply was found and a mild winter cut demand. Neither of those was a rate decision.
Nothing directly. They could only slow everything else, so the gas rise stopped spreading.
Right. The rate rise was aimed at everything except the gas. If everyone asks for more pay to cover the gas bill, and every shop raises prices to cover the pay, the gas rise turns into a rise in everything. The rate rise was there to stop that. The next lesson is about that loop.
Make the shortage worse.
Not yet. It did not touch the supply of gas either way. What it touched was borrowing, and the spending that runs on borrowing.
Lesson complete
A rate rise works on how much people want to buy. A shortage is not that.