What is monetary policy?

Monetary policy is the set of tools a central bank uses to control the supply of money in an economy, manage inflation, and influence economic conditions. In the United Kingdom, monetary policy is set by the Bank of England's Monetary Policy Committee, which meets eight times a year to decide the level of the base rate and the size of the Bank's asset purchase programme. The MPC operates independently of the government: it has a mandate to keep CPI inflation at 2 percent, and it uses monetary policy to pursue that target without taking instructions from ministers.

The main tool: the base rate

The primary instrument of monetary policy in the UK is the Bank of England base rate. This is the interest rate at which the Bank of England lends money to commercial banks overnight. Changes to the base rate flow through the financial system: when the base rate rises, commercial banks raise their savings and lending rates; when it falls, they reduce them. The result is that borrowing becomes more or less expensive across the whole economy, affecting mortgages, business loans, credit cards, and other forms of credit.

When inflation is above target, the MPC raises the base rate to slow spending and ease price pressure. When growth is weak and inflation is below target, it cuts the rate to stimulate activity. The base rate was cut from 5.25 percent to 4.25 percent through 2024 and 2025 as inflation fell back from its post-2022 peak. For the current rate and the trajectory of future cuts, see our note on whether UK interest rates are going down.

Quantitative easing and quantitative tightening

When interest rates reach very low levels and further cuts are impractical, central banks can use additional tools to ease monetary conditions. The main alternative tool used by the Bank of England is quantitative easing: the creation of new money to purchase financial assets, primarily government bonds. QE lowers long-term borrowing costs even when the base rate cannot be reduced further. For a full explanation, see our note on what quantitative easing is and how it works.

The reverse process, quantitative tightening, involves reducing the Bank's holdings of assets by allowing them to mature or selling them back into the market. The Bank of England has been running QT since 2022 alongside the rate-rising cycle, withdrawing some of the liquidity created during the pandemic QE programme.

Monetary policy versus fiscal policy

Monetary policy and fiscal policy are the two main levers for managing an economy. Monetary policy operates through interest rates and money supply, controlled by the independent central bank. Fiscal policy operates through government spending and taxation, controlled by the elected government. The two policies interact but are set by different institutions with different objectives and different time horizons.

A key difference is speed. Monetary policy can be changed quickly: the MPC can raise or cut the base rate at any meeting. The effects take time to feed through, typically six to eighteen months, but the decision itself is immediate. Fiscal policy changes through the Budget and Spending Review cycle, which means new measures often take a full year to be legislated and implemented. For the full picture on fiscal policy and how it interacts with monetary decisions, see our note on what fiscal policy is.

Why monetary policy independence matters

The Bank of England became operationally independent in 1997, when the government handed the rate-setting decision to the MPC. The rationale is that elected governments face electoral incentives to keep rates low before elections and stimulate the economy beyond what is sustainable. An independent central bank, insulated from those pressures, can make decisions based on the inflation mandate without political interference. The MPC publishes the minutes of each meeting and the vote of each member, making its decision-making transparent.

The Briefed daily briefing covers every MPC decision and quarterly Monetary Policy Report. For the scheduled meeting dates, see our Bank of England MPC meeting dates page. Free, weekdays at 6:45am.