How Bank of England Sets Interest Rates in UK

There are many different interest rates in the economy for mortgages, personal loans, poor credit loans e.t.c. They are set by a range of banks and building societies. The Bank of England cannot directly control these but influences them indirectly through changing the BASE Rate. (or the REPO rate)

How Bank of England determines Interest Rates

· The Bof E keeps the banking sector short of cash
· Commercial Banks have to borrow from the B of England .
· The interest rate the Bof E charges the commercial banks will affect all interest Rates

1. The Bank Of England likes to keep the banking system short of cash. This could be done by

a) selling long term securities to the banking system thereby reducing liquidity.
b) The bank can restructure the national debt by selling more long term bonds and less short term gilts

2. To obtain cash banks can sell bills before they are due for repayment. These Bills are bought at a discount, exactly how much discount determines the rate of interest

3. The commercial banks can enter into a “gilt Repo” agreement. This occurs when a bank agrees to sell the Bank of England gilts and repurchase them in the future. The repo rate is the rate of interest applied to the loan with gilts as securities.

4. If banks have to pay higher interest rates to borrow from the bank of England they will tend to pass this onto their consumers

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