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
FIRMS
EXCHANGE RATES
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