IN December last year, the Bank of England Base Rate of Interest was 0.1%. After last Thursday's increase of 0.75%, it now stands at 3%.
The speed and extent of these increases of course mirror the high rates of inflation the UK has had during 2022. As I am sure you are familiar with, higher interest rates mean more households save and fewer borrow to spend on Consumption. Also, fewer firms borrow money to spend on Investment. Taken together, this reduces AD which should also cause the Price Level to fall.
As the article linked to below mentions, another effect is that UK Exchange Rates should rise. The mechanism is via "hot money flows" - flows of financial investment money that moves around the world looking for the best interest rate. If UK interest rates rise, more hot money financial investors want to deposit money on the UK. They need to convert currency into Pounds to do this, leading to more demand for Pounds and thus a rise in the "price of Pounds", that is, the exchange rate.
Since Stronger Pound = Imports Cheaper, Exports Dearer, this reduces the Net Trade (X-M) balance, meaning lower AD and a lower Price Level.
It is essential in an essay on the effects of higher interest rates on inflation to mention the C and I effects. Mentioning the effect on X-M is a good way to get even higher marks, as long as you understand it fully and have enough space to explain it properly.
Full article:
https://www.thisismoney.co.uk/money/mortgageshome/article-11385431/What-0-75-rate-hike-means-mortgage-savings.htmlhttps://www.thisismoney.co.uk/money/mortgageshome/article-11385431/What-0-75-rate-hike-means-mortgage-savings.html
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