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Interest Rates

 

The Bank of England changes the interest rate in order to control the rate of inflation.  The Bank of England aims to keep inflation within 1% of its target of 2.5%.  If it appears that inflation is getting too high, the Bank will increase interest rates and conversely, if inflation is getting to low rates will fall.

 

Increases in Interest Rates

This will affect a firm in a number of ways:

HOUSEHOLDS
  • Individuals will save more, therefore their level of consumption will fall.  Firms will see a fall in their level of sales.
  • As mortgage repayments have gone up, disposable incomes will fall.  Households will have less money to spend on other goods, again businesses will expect their level of sales to go down.
  • It become more expensive to borrow money, thus individuals will be more reluctant to purchase items on credit.  Sales of more expensive products will fall.

 

FIRMS
  • Investment projects become more expensive as repayments on any loans will go up.  Businesses will therefore be less likely to undertake large investment projects.

 

EXCHANGE RATES
  • A greater number of individuals and firms will want to invest money in the UK to take advantage of the higher interest rates.  This will cause the pound to appreciate, as more people demand it. 
  • A strong pound makes exports more expensive (SPICED), reducing the number of UK goods demanded abroad.
  • A strong pound makes imports cheaper (SPICED), increasing the number of foreign goods demanded in the UK.  The more customers buy from abroad, the less they will purchase from UK manufacturers.

 

Decrease in Interest Rates

This will affect a firm in a number of ways:

HOUSEHOLDS
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FIRMS
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EXCHANGE RATES
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E-mail Steve Margetts