Factors behind decision for first interest rate rise in 10 years

interest rate paid on deposits.

To understand why the MPC decided to raise Bank Rate, it is important to remember that Parliament has given the MPC responsibility to keep the rate of inflation – the pace of increase in prices of goods and services – at 2% a year. CPI inflation is currently around 3%.

To ensure that the rate of inflation comes back down to target, a majority of those on the MPC agreed that Bank Rate should increase a little, starting with a rise of a quarter of one per cent.

What has the MPC based that judgement on? Well, one positive aspect of the UK economy is that the unemployment rate is at its lowest level since 1975. Indeed, one million more people are in work than just two years ago.

More jobs means more people have money to spend which will support consumer demand.

But, the very low level of unemployment is also likely to mean that wages will begin to increase more quickly, as companies compete to take on new staff and keep their existing workers.

In my regular conversations with employers in the West Midlands, it is becoming more common for them to say that the next pay rises are going to be a little higher than in recent years.

And if wages increase more rapidly, then prices in the shops will begin to rise more rapidly, as companies charge more to pay for staff costs. That means a higher rate of inflation. Also, with so few people now out of work, there isn't much scope for the economy to grow from increasing the size of the workforce.

The main thing that will determine how quickly our economy can grow in the future, or the ‘speed limit' of the economy, will be the extent to which we are able to produce more with what we have.

The MPC thinks that the UK economy is currently growing at around its speed limit. If it were to grow any faster, that would push up on inflation.

As a result of these factors, the MPC decided that a small rise in interest rates now is necessary to control inflation in future.

While this will increase borrowing costs for some, we expect the impact to be modest. More people are on fixed-rate mortgages compared to the last time there was an interest rate rise. And, of course, higher rates are better for savers.

The MPC expects that any further rises in interest rates will happen gradually and to a limited extent. It currently anticipates that perhaps a couple more quarter of a per cent increases in Bank Rate are likely to be needed over the next three years.

To assist the MPC, my colleagues and I in the Bank of England's Agency network will continue to act as ‘the eyes and ears' of the Bank.

We speak to diverse organisations in the West Midlands and around the UK and feed what we learn directly into our policymakers in London.

In this way, the people and organisations we speak to are helping policymakers make decisions on how best to guide the economy through these uncertain times. Graeme Chaplin is Agent for the West Midlands & Oxfordshire

at the Bank of England