ARTICLE 3: Why are Bank Of England, Inflation & the Interest Rate relevant to the Coronavirus (COVID-19) pandemic? by Shane Hindocha
In these uncertain times, it is important to look ahead, stay attentive and proactively navigate your way through the turmoil.
My name is Shane Hindocha. I am a father, a husband, an active property investor & an entrepreneur. I have lived through 2 recessions already. If we are going down this route (recession) again, a blend of hindsight and foresight is welcomed. Whilst my outlook on life is generally positive, I will remain objective and then form an opinion.
My aim is to break complex information down into digestible and easy-to-understand formats…and in particular, how the current situation will affect property prices in the UK.
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BANK OF ENGLAND?
Bank of England (BoE) is UK's central bank.
Their mission:
- to promote the good of the people by maintaining monetary and financial stability.
Their job:
- control money supply
- maximise employment
- stabilise prices
- act as the lender of last resort
- custodian of the official UK gold reserves
Inception of BoE was in 1694.
The BoE has served the public for over 300 years by looking after the UK economy and financial system.
BoE is separate from government.
BoE is responsible for keeping inflation (price rises) low and stable.
The UK Government sets the BoE an inflation target of 2%. This helps everyone plan for the future which I will explain in a little more detail shortly.
In order to maintain monetary stability, the bank has delegated the role of formulating monetary policy to the Monetary Policy Committee (MPC), a 9-member committee led by the Governor (Andrew Bailey replaced Mark Carney as governor).
MPC (Monetary Policy Committee) meets every month to 6 weeks to decide the Bank Rate.
INFLATION?
Inflation is a measure of how much the prices of goods (such as food or electronic items) and services (such as haircuts or travel) have gone up over time.
To do this, they need to have a so-called “shopping basket” of goods and services.
So, how do they do this?
Each month, the Office for National Statistics (ONS) collect around 180,000 prices of about 700 items. They use this ‘shopping basket’ to work out the Consumer Prices Index (CPI).
CPI is the measure of inflation we target & inflation is determined by the state of the economy.
Earlier I said, the UK Government sets the Bank of England an inflation target of 2%. This helps everyone plan for the future.
If inflation is too high or is unstable (ie. it moves around a lot) it’s hard for businesses to set the right prices and for people to plan their spending.
If inflation is too low, or negative (deflation), then people tend to put off spending because they expect prices to fall. Although we all see lower prices as buying opportunities (which seems like a good thing), it actually isn’t. If everybody reduced their spending because we are constantly expecting prices to fall further and further, then companies could fail and people might lose their jobs.
BANK RATE?
The Bank of England base rate is often called the interest rate, bank rate or base rate.
Domestic banks borrow money from a nations’ central bank (in this case, the central bank being BoE). The Bank Rate is the interest rate at which the BoE will lend money to domestic banks (usually in the form of very short-term loans).
Managing this bank rate is a lever the BoE uses to affect economic activity. In fact, the bank rate is used primarily to help regulate inflation…but it also influences what you pay for borrowing money, and what banks pay you for saving money with them.
The base rate is currently 0.1%. This is the rock-bottom level, known as the 'lower bound' in central banking language.
During a special meeting of the Bank’s MPC on 10th March 2020, the BoE decided to cut the interest down from 0.75% to 0.25% to counter the "economic shock" resulting from the coronavirus outbreak (reduced Bank Rate by 50 basis points). On Thursday 19th March 2020 (today), the BoE reduced the bank rate to 0.1%, as I predicted in my earlier articles and videos.
HOW DOES A LOWER INTEREST RATE IMPROVE THE ECONOMY?
Signs of a slowing economy = less spending and less lending.
If people are not going out to:
Events / Cinemas / Restaurants / Shops / Bars / Theatres / etc etc
= less spending happening in the economy.
If more people fall ill, go into isolation, then less people to serve in shops etc
= people feel nervous and they start to hold / save their money (in case they lose their jobs, in case their business collapses etc)
Lower interest rates make the cost of borrowing cheaper. It encourages consumers and firms to take out loans to finance greater spending and investment.
By lowering the interest rate = more lending, more people borrowing (car loans, mortgages etc) = more spending.
The BoE said, “The reduction in the bank rate will help to support business and consumer confidence at a difficult time, to bolster the cash flows of businesses and households, and to reduce the cost, and to improve the availability, of finance.”
But interest rates can only go down so far. Right now, the interest rate is the lowest it has ever been….& so the BoE will pump £200bn into the economy through its' quantitative easing (QE) bond-buying programme as it seeks to steer the economy through this difficult period.
Quantitative Easing is what I expected and anticipated and I will be explaining this in my next article.
Let’s hope the PM is right and we “send Coronavirus packing in the next 12 weeks!”
Stay safe, remain positive and & be proactive.