UK Government's Strategy to Combat Inflation through Interest Rate Hikes

This report discusses the UK government's strategy to combat inflation through interest rate hikes. It explains how interest rates impact the purchasing and lending power dynamics and how the government is using this strategy to bring down the inflation rate. The report also highlights the advantages and disadvantages of this strategy and its impact on the UK economy.

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Contents
INTRODUCTION...........................................................................................................................1
MAIN BODY..................................................................................................................................1
CONCLUSION................................................................................................................................4
REFERENCES................................................................................................................................5

INTRODUCTION
Inflation refers to the periodic increase in the price value of the goods and services in an
economy which leads to erosion of purchasing power of the citizens of a given country. This
report will highlight the ways in which the UK government is undertaking activities to combat
the inflation rate with focus on interest rate manipulation (Cornea‐Madeira and Madeira, 2022).
MAIN BODY
According to the economic school of thought and major prevalent economic theories,
interest rates are one of the best ways to counter inflation in an economy as the rate of interest
which is prevalent in a country directly impacts the purchasing and lending power dynamics.
When inflation rate is rising at an alarming rate or is on a gradual rise than the federal reserve
raises the interest rates to slow down the economy considerably resulting in the inflation rate
going through a downward trend (Boyce, and et.al., 2018). This relationship between inflation
and interest rates is also quite paradoxical as inflation is often associated with the rising standard
of living and economic growth however in economy’s such as UK where the inflation rate has
been devastating in the light of the COVID-19 pandemic and Brexit and has increased faster than
the rise in wages, the government has implemented several control and combative measures to
counter inflation with interest rates being a focal point of their joint efforts toward lowering
inflation.
1

Figure 1 Inflation rate in UK
Due to the soaring inflation rates in UK, the Bank of England has hiked the interest rate
by 50 basis point which is a 27-year high recorded since 1995 and this strategy is being used by
the government as it has had to deal with situations resembling that of a recession due to a
combination of COVID-19, Brexit and Vladimir Putin’s invasion of Russia. One of the major
advantages of making such intense hike in interest rates is the prediction made by the UK federal
ban k that UK will hit negative growth for the entirety of 2023. By raising the interest rate on
borrowings by the UK central bank, the government can suck the dynamism and growth rate of
the economy which according to industry predictions can bring inflation rate down to 2% in later
half of 2023 (Bank of England hikes rates as it predicts 13% inflation and long recession, 2022).
2

Figure 2 Rise in interest rate by UK Federal Bank
This strategy of relying on interest rate hiking to combat inflation has been yielding
positive results for the UK government as the inflation rate fell from 10.1% in July to 9.9% in
August. However, the banks are still not relaxing due to future price hike predictions and the
federal bank will continue to keep the risen interest rates for now. In theory, this move of the
government is aimed at making better off households spend majority of their income in imported
goods which will cause sellers to increase their prices further. The higher interest rate hike
strategy by the government is built to make people reign in their savings as the higher interests
will gradually eat through savings and mortgage bills (Bank of England will not take foot off
throttle despite drop in inflation, 2022).
3

Figure 3 UK Economy forecast
CONCLUSION
It has been concluded from the above report that inflation is quite prevalent in the UK and
one of the major ways that UK government is mending the inflation rate is through interest rate
hikes. This strategy is bearing fruit as the inflation rate is on the decline although future outlook
of the economy is quite rough.
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REFERENCES
Books and Journals:
Boyce, and et.al., 2018. Central bank interest rate decisions, household indebtedness, and
psychiatric morbidity and distress: Evidence from the UK. Journal of affective
disorders, 234, pp.311-317.
Cornea‐Madeira, A. and Madeira, J., 2022. Econometric Analysis of Switching Expectations in
UK Inflation. Oxford Bulletin of Economics and Statistics.
Online referencing
Bank of England hikes rates as it predicts 13% inflation and long recession, 2022 [online]
available through < https://www.theguardian.com/business/2022/aug/04/bank-of-england-raises-
interest-rates-to-1-point-75-per-cent-in-biggest-hike-in-27-years>
Bank of England will not take foot off throttle despite drop in inflation, 2022 [online] available
through < https://www.theguardian.com/business/2022/sep/14/bank-of-england-will-not-take-
foot-off-throttle-despite-drop-in-inflation-interest-rates>
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