Outlook: The Bank's last cut is the slightest

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The Independent Online
THE DIFFERENCE between 5.25 per cent and 5 per cent in economic terms is precisely zero. The series of seven interest rate reductions from a peak of 7.5 per cent since October has certainly had an impact, making the difference between outright recession and gentle slowdown for the UK at a time of immense global economic turbulence. But the last small cut in a series is bound to be marginal.

What's more, the mortgage lenders have taken it upon themselves to stop the Bank's medicine working on consumer demand by failing to pass on the last two quarter point cuts to homeowners. But at least industry surely has good reason to be grateful. The instant reactions could hardly have been more appreciative. After grumpily greeting previous rate cuts as not enough, the unions praised the Bank's vision and leadership.

Yet the gilts market reacted so adversely to the decision that longer term interest rates rose by half as much as the Monetary Policy Committee cut short rates. The gilt market is not only reassessing its optimism about the UK joining the euro in two or three years, which would imply much lower UK interest rates, but also has an eye on the likelihood of an increase in US interest rates soon.

In other words, both the channels though which monetary policy can affect the economy are likely to be ineffective this time. The importance of yesterday's decision is mainly symbolic, and if it has any impact on the economy it will be through cementing recent improvements in confidence.

As the more thoughtful pundits pointed out - and as the Chancellor underlined in his Mansion House speech last night - interest rates are no panacea for the British economy. In the competitive environment of a globalised world the job of monetary policy is to avoid big mistakes and maintain a stable macroeconomic environment. This is doubly true as long as the pound remains at an uncomfortably high level.

Some City economists believe the Bank will have to cut rates once or twice more before sterling starts to weaken significantly, but given that the reductions so far have had scant impact on sterling, this might be the triumph of hope over experience. And the verdict of the markets yesterday is that interest rates will be on the increase by early next year. That gives industry six months to make the most of the lowest borrowing costs for 22 years.