Just what exactly can the Bank of England do?

Canarius's picture

It’s no surprise that our economy is in a sorry state at the minute. Not only is it slowing at the fastest pace in nearly 16 years, house prices continue to fall rapidly whilst fuel and food prices seem to increase by the day. Now the Bank of England’s job is to control inflation, to keep it around the 2% mark. However, it’s currently 3% (if you take the consumer prices index as gospel) and the majority of economists expect this figure to rise when it is announced next week - as the cost of living continues to bite our wallets.

But what exactly can the Bank of England do? This month it chose to sit on its hands and keep interest rates on hold at 5% - but was this the right choice? Let’s have a look at the options...

Option 1) Cut interest rates

Let’s face facts. Big business wants lower interest rates to spur domestic demand and kick-start our flagging economy again. Confidence may be restored in the property market, whilst mortgage owners on tracker deals will breathe a sigh of relief. Unfortunately this option seems to be out of the question, because inflation will soar (as we have more money to spend).

Option 2) Raise interest rates

Oh dear. Although savers may cheer, raising interest rates has the potential to turf the thousands of homeowners already struggling to meet their mortgage payments out of their homes quicker than they can say Gordon Brown. Inflation may start to come down (as we all have less money to spend), but this will make the painful effects of the credit crunch even worse.

Option 3) Sit on its hands

This is perhaps the only viable option - it’s certainly a gamble and it will win Mervyn King no friends in the City. The Brown and Darling double act will quake in their boots, hoping that not only we spend less and save more, but pray that oil prices come down and that mortgage lenders start pricing their deals nearer this mark. These all have the potential to bring down inflation, but with banks not lending to each other and mortgages becoming even more expensive, this won’t happen any time soon.

Poor old Mervyn King is stuck between a rock and a hard place – he’s damned if he does, and he’s damned if he doesn’t.

Your Comments

The Bank of England no longer control lending rates, inflation or the UK economy as the banks themselves do this through the LIBOR rate. Whatever Mervyn King does will have no impact unless the banks independantly decide to follow suit and adjust the LIBOR rate. Old Merv and the BoE committee are powerless to the fat cat bosses of Londons main financial institutes.

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