How the Bank of England creates inflation

How inflation is created

When the Bank of England expands the money supply at a greater rate than that needed for the level of economic activity in the country, inflation occurs. The Bank of England expands the money supply by lowering its base rate and by counterfeiting money. This suppresses borrowing costs and encourages people and businesses to borrow.

Suppressing interest rates increases lending

The biggest effect of suppressing interest rates and counterfeiting money is on house prices. When people are able to borrow more due to suppressed borrowing rates, they are able to bid up the prices paid for housing and other residential property. This is shown in the chart below where rising house prices are contrasted with the rising money supply.

Bank of England House Price Inflation vs Money Supply, 2009 to 2021
Average House Price vs Money Supply. Data from the Nationwide Building Society and the Bank of England

Lending creates the money supply

Because bank lending creates money, a big part of the increase in money supply comes from this newly created mortgage debt. The chart below shows the money supply broken down into residential mortgage loans outstanding, other loans outstanding (which includes all other personal and corporate bank loans) and the Bank of England's counterfeiting.

Money Supply Breakdown, 1999 to 2021
Money Supply Breakdown, 1999 to 2021. Data from the Building Society Association and the Bank of England: Counterfeiting, Money Supply

Excess money supply creates inflation

The new money created from borrowing now has to find a purpose in the economy, and because most of it can't it simply goes into inflating the future prices of housing, goods and services.

Find out more about the Bank of England's inflation