How does an increase in Bank rate lead to lower inflation? Explain using the monetary policy transmission mechanism.

The aim of the Bank of England (BoE) is to keep inflation within the set target of +-1% of 2% CPI. Therefore, as part of it's monetary policy, the BoE increases the Bank rate to lower inflation in the economy. Bank rate is the interest rate the BoE charges on its loans to commercial banks. A rise in Bank rate will affect the economy as follows:There will be a higher market interest rate because it becomes costly for commercial banks to borrow from the BoE. This rise in cost of borrowing of commercial banks will be passed in form of higher general interest rate in the economy. This will lower borrowing in the economy and increase savings. People with mortgages will see a rise in their interest payments and so their spending will also fall. Businesses are less likely to invest because the cost of taking out a loan will increase. All these will lower aggregate demand in the economy, which will in turn lower inflation. (Can be shown in a diagram)As mortgage repayments are now costly, demand for houses in the economy will fall and so house prices will also fall. This will lead to lower confidence in the economy. There will be a negative wealth effect for people currently owning houses and their spending will also fall. The Bank rate impacts expectations and confidence in the economy. A rise in interest rate will indicate that in the future, growth will be lower. This will dampen business and consumer confidence. This will in turn lower aggregate demand. A rise in Bank rate will attract foreign investors to save in the UK. This will increase the demand of British pounds and so we will see an appreciation of the exchange rate (Can be shown in a diagram). An appreciation of £ will lead to lower import prices and cost of production of businesses. This will lower cost-push inflation in the economy. It can take up-to 1-2 years for the full effects of change in interest rate on real GDP and inflation to materialize.