In 1997 the new Labour government gave monetary independence to the Bank of England. This means the Bank decides what to do without political interference. The Bank created the Monetary Policy Committee (MPC) which is given the job of deciding on the level of interest rates. They have a target of 2.5% inflation +/- 1% (1.5% - 3.5%).

If inflation looks to be getting too high, then they will raise interest rates. This affects businesses and consumers.

1. Consumers will find it more attractive to save more and spend less. They will find it more expensive to borrow money for spending. Most consumers also have mortgages. The repayments become more expensive so their disposable income falls and they spend less. Overall, spending in the economy falls.

2. Businesses find it more expensive to borrow money for investment and growth. Investment spending is also spending in the economy, and this falls.

Of course, there is a cost to this, because growth and employment are reduced, so the Bank has to weigh this up carefully. If inflation looks too low, it cuts interest rates with the opposite effect, and growth and employment are increased.