Can someone explain interest rates to me

More specifically why, when costs go up, do they increase interest rates? From what I can gather it's to discourage people from spending money and encourage saving in order to somehow cause prices to fall.

But how does it make prices fall? I don't see how forcing a barely surviving family to pay extra on their mortgage will bring down the cost of petrol.

It just feels like all it does is makes the rich get richer with more interest on their savings while forcing the poor who don't have surplus money to spend more money they don't have just to keep a roof over their head.

 

I’m not saying it does, because I really don’t know, but it sounds like supply and demand. If no one is buying anything, prices are reduced to tempt people into buying. When people are buying loads of things, prices go up because demand is high and they know people will pay it.

 

The basic theory behind it is that higher interest rates dampen down consumer spending - which cools inflation, so JamDrop is basically right if you interpret 'demand' to be consumer spending of sterling - people are less willing to spend because the cost of borrowing is higher.

As I said earlier though, my view is that really it's pissing in the wind when you look at how the macroeconomic and environmental factors (Brexit, lockdown, Ukraine) are stacked against the economy and importantly the massive programme of QE in Western countries, which has worked to fuel inflation precisely through the opposite effect of what I've just described - it increases consumer spending power (demand) and so prices go up and inflation rips rampant.

 

I don’t disagree that QE has stoked inflation, but the current situation is purely driven by a crap economic outlook caused by Brexit on top of the war in Ukraine fuelling energy price increases. Oil alone hasn’t caused this as when oil was $144 a barrel, petrol was around £1.20. The difference is then it was $2 to the pound. Now it’s £1.20.
And that is caused by Brexit

 

As I understand it, your general thrust is right but for institutional spenders, not individual ones. It's HSBC and the like who are being nudged to change their behaviour, not Joe Whatsername with their mortgage.

I mostly blame Cameron and Osborne for this (although I've said that before and somebody rightly pointed out that the groundwork was laid much earlier!). It's very much like their trick of equating cutting spending to pay off the national debt with not having a takeaway and increasing the direct debit payment towards your credit card.

 

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Can't say I agree with everything he says, he argued that he didn't see major inflation happening, though obviously the war in Ukraine has exacerbated matters since it was written.

 

Good luck to anyone managing to save anything at the moment with the cost of living gas electric wiping out what most people would have probably had to save in theory anyway.

 

Interest rates have actually been pretty stable for donkeys years however when we got our first mortgage in 1978 we had to pay a rate of 10.5 % & incidentally we were in power in those days , Callaghan was the PM , my point is that over the years there has been fluctuation & even with todays rise to 1.5 % rates are actually extremely low although that is no comfort to struggling families , back then in 1978 I found keeping my head above water a real challenge .

 

That's just oil though. US inflation is at 8.6% - that's not Brexit, and Biden just happens to be the largest driver of QE in world history.

On the day before the Brexit vote in June 2016, the dollar exchange rate was $1.42, so you have also massively exaggerated the exchange rate impact.

I'm as anti Brexit as anyone but anyone who pretends that Brexit is the primary driver of inflation over and above QE is deluding themselves.

 

You're right on the last point. Brexit is an exacerbating factor in our levels of inflation but not the primary factor.

There is also a significant supply side delay and shortage which is making an inflationary contribution.

Could be worse though... we could be experiencing what the Turks are enduring. 73% I think was the last figure I saw.

 

Yep agreed - the lockdown impact - but I didn't dare say it ;-)

 

The idea that you can reduce inflation caused by supply-side shocks (covid, war in Ukraine) with monetary policy (interest rates) is totally perverse. The result is stagflation - or in this case, recession and inflation.

 

But the prices never fall when interest rates are falling

 

No reason not to mention it. It is a part of the global economic world we find ourselves together with scarcity of supply of some key goods.

 

You have a very significant problem in a large number of sectors if prices are consistently falling. If prices are always cheaper tomorrow, why buy today?

 

Just to put a bit of balance in here, its a bit of a sweeping statement there saying it makes the rich get richer.
On one hand it might , but there's lots of 'ordinary' older folk like us who really struggled paying high interest rates when we had mortgages and then have virtually got sod all on our savings since the mortgage finished and saving rates plummeted.
Now I agreed it will be harder on people with mortgages , but just pointing out there's others who have struggled to build up ( for instance) a decent pension pot due to crap investment/ savings rates while the ones with incredibly low mortgage rates have benefitted.

 

It's been mentioned many times before about house prices vs interest rates.

House prices are insane now and the level of salary required to buy in many areas is extraordinarily high. If interest rates were to push higher than 2.5-3.5% (so a mortgage of likely 4.5-5.5%) there would be major issues and I'd suspect the housing market would seize up somewhat, if not have something of a crash.

I don't disagree with you by the way. Every generation will have challenges. The days of insane interest rates were dampened to a degree with lower affordability levels and borrowing factors, though the speed of interest rate rises was far too fast for many to contend with.

 

History.

It's worked int he past, so they think it will work again.

The Bank of England don't have many tools in their toolbox to control inflation and so they use this, even though it's the 'wrong kind of inflation' they still see that it will have an effect.

It's using a rake to knock in a nail. But when all you have is a rake....

 

Inflation kills savers and rewards debtors, interests rate rise isn’t going to help your high street saver with inflation likely to top double figures, but it does decrease the value of government debt, so that’s ok then….