In a nutshell
The economy now needs a little less support
We cut interest rates to exceptionally low levels during the financial crisis to support spending and to reduce the number of people out of work.
Over the past few years our economy has needed interest rates to stay very low as we recovered from the global financial crisis.
But things are changing. The world economy is now growing strongly. In the UK, the share of people without a job is at its lowest level for over 40 years, and businesses are finding it hard to recruit people. Our economy is probably growing about as fast as it can without overheating. And inflation is above our 2% target.
Inflation and the fall in the pound
Our job is to meet the 2% inflation target. Inflation is currently above that target, because of the big fall in the pound following the Brexit vote.
The lower pound has meant that things businesses get from abroad cost more. Businesses will need to pass those rising costs on to their customers. So that has meant higher prices in the shops.
The fall in the pound happened around 18 months ago. Its effect on inflation doesn't last forever. And in the next few months inflation is going to start to fall back gradually towards our target.
A strong world economy
Just like at home, the world economy had been quite weak following the financial crisis. But across Europe, in the US and many other countries the economy is now growing strongly.
Stronger growth abroad will benefit the UK by increasing demand for our exports. And it should encourage companies to invest and recruit more staff to meet this extra demand.
The squeeze on pay is easing
Over the past year, prices have been rising faster than wages. That means people have not been able to afford as much. We think that is changing.
The share of people out of work is now at its lowest level since 1975. And there are a lot of job vacancies. This means that companies are having to compete hard with each other to recruit and retain workers. One way they do that is by offering higher wages – so we expect bigger pay rises over the next few years.
We think that pay will rise faster than prices this year, easing the squeeze on living standards.
Getting inflation back to target
To make sure inflation falls back to our 2% target, we need to set interest rates so that the amount of spending in the economy isn't too low or too high. If we set interest rates too low, then growth in the economy will be too fast, and inflation will stay above our target. But if we set interest rates too high or raise them too rapidly then growth will be too slow, and inflation will fall below our target.
Put another way, we need to keep the economy growing at its speed limit.
The speed limit for the economy is determined by two things: how many people are in work; and how productive the businesses they work for are.
A few years ago many more people were out of work. So there was scope for the economy to grow quite quickly as a lot of those people found jobs.
Now, with a record number of people in work, there isn't much more economic growth that can come from unemployed people finding work. Instead, it will mostly need to come from higher productivity - our ability to produce more with the people already in work and the resources that we have.
But productivity has barely risen over the past decade. And we think that productivity will probably grow relatively slowly in coming years, too.
We think that for inflation to settle back at the 2% target, the economy probably needs to grow at around 1½% in coming years.
The interest rate decision
Inflation has been above our 2% target over the past year because of the sharp fall in the pound triggered by the EU referendum. During that time, we had to balance how quickly we take inflation back to the target with the support we give to jobs and activity. To ensure a sustainable return of inflation to the target, we need to keep economic growth around its new, lower, speed limit.
With a strengthening world economy and more people in work, the UK economy now needs a little less support from us. We raised interest rates in November from 0.25% to 0.5%. If the economy continues to perform as expected, we think we will need to raise them further, reducing the amount of support we are providing to the economy. We expect any further rises in interest rates to happen at a gradual pace and to a limited extent. Interest rates are likely to remain substantially lower than a decade ago.