Q&A: interest rates
Updated on 12 June 2007
Mervyn King has warned that house prices may rise further. How are interest rates decided? Channel 4 News online explains.
Who decides interest rates?
The Bank of England's Monetary Policy Committee (MPC), which meets every month decides.
The MPC is made up of the governor of the Bank, two deputy governors, a chief economist, a marketing director and four external members, appointed by the chancellor for a three year term. Each member has a vote of equal weight.
So this unelected bunch decide how much I pay?
Well, yes. Traditionally, it was the Treasury that set interest rates, but Gordon Brown granted the MPC powers to set rates when Labour came to power in 1997.
The idea was to prevent governments from using interest rates as a political tool and aimed to instill a degree of independence between the economy and political concerns.
In times of emergency, however, the government reserves the right to instruct the Bank on what rate to set.
What is the main aim of the MPC?
Its aim is to control inflation according to the government's inflation target, set each year in the Budget.
For the year from March 2006, the target was 2 per cent on the consumer price index controlling inflation. The secondary aim is to support the government's economic policies, and targets for growth and employment.
The Bank's governor must write an open letter of explanation to the chancellor if inflation exceeds the target by more than one percentage point in either direction.
In April, 2007, Mervyn King, wrote the first such open letter, explaining why inflation had reached 3.1 per cent - more than one point beyond the target of 2 per cent.
Why does the Bank of England raise base rates?
The Bank is increasingly concerned about inflation. After years of tame prices, the consumer price index (CPI) has been above its two per cent target for seven consecutive months.
The concern is that rising prices will fuel higher pay demands which could push prices yet higher in an inflationary spiral.
Why is inflation rising?
A quadrupling of the price of oil has fed through into higher petrol prices and household utility bills.
High levels of employment, soaring house prices and increased household borrowings have kept consumer spending on the boil. Even food prices are rising after years of decline.
What about house prices?
The property market in the UK has gone through an unprecedented boom.
On average, house prices have doubled since the middle of 2001 and recently, growth has once more accelerated into double figures. But most market-watchers expect price inflation to cool.
A big factor in the relentless rise of house prices has been speculation - the belief that prices will continue rising, no matter what.
Families with a typical £100,000 home loan have seen their monthly repayments increase by £63.79 after four interest rate hikes since last August.
So what is Mervyn King saying?
Mr King's warning comes as the official level of inflation fell from 2.8 per cent to 2.5 per cent. But the situation for some homeowners - and for first time buyers - looks bleak, with mortgages now at their least affordable level for 15 years.
