How do higher interest rates bring inflation down?
- It also means savers get a bigger return (ie they make more money by not spending) and potential borrowers find it is more expensive to take out a loan. These things make it less attractive for people and companies to spend money.
- Higher interest rates lead to higher charges on many mortgages and loans, meaning people must spend more on them and less on other things.
What is happening with inflation?
- Inflation has come down a long way since its peak almost four years ago – the events that led to price rises have settled down and raising interest rates has had the desired effect.
However, we predicted that inflation would follow a bumpy path – it rose to 3.8% in July 2025. This was, in part, because of rising food prices after bad weather damaged harvests. Prices of services also increased, eg at hotels and restaurants. It was still at 3.8% in September 2025 after food prices fell but petrol price and airfare inflation rose.
In November 2025, we said we believed inflation had peaked and that it should fall back towards 2% over the next year or so. It was 3.4% in December 2025.
Learn about the economy
Inflation and interest rates
Payments and spending
borrowing and saving
Money, and spending
What is legal tender?
Why was inflation so high a few years ago?
Three things caused it to rise.
The first was the coronavirus pandemic. There was a large shortage of products and services; then, as lockdowns eased, there was suddenly huge demand for them, and inflation rose. Put simply, when there’s not much of something but lots of people want it, the price goes up.
We knew that wouldn’t last long. But then came Russia’s invasion of Ukraine, which had a large impact on energy and food prices.
- For example, the war caused the supply of gas from Russia to drop significantly, and gas prices rose as a result. Higher energy costs make it more expensive for businesses to produce other goods and services – so they raised their prices as well.
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