ALEX BRUMMER: Optimism is returning; now the Bank must relax and continue cutting

Much of the country will be celebrating the Bank of England’s decision to cut interest rates by a quarter of a percentage point to 5 percent.

The belated move, after keeping the bank rate at 5.25 per cent for a year and a parade of 14 rate hikes from December 2021, will come as a welcome relief to consumers, people with mortgages, businesses and the Treasury.

The government is the country’s largest borrower, and lower interest rates reduce the cost of servicing the nation’s debt.

The change will not be welcomed by everyone. There are more savers than borrowers.

Inflation, which peaked at 11 percent, caused the value of such holdings to decline.

It was only in recent months, as the cost of living fell, that savers began to see real returns on their deposits.

Governor Andrew Bailey is expected to be right and traditional banks will recognise the value to their own stability of paying decent returns on term deposits, encouraging savers to leave their money untouched for a year or more.

Among those who are not too happy with the Bank’s decision and the likely downward trend in interest rates from now on is the Chancellor of the Exchequer. Lower rates should be good for Rachel Reeves’ growth agenda.

But in her response to the change, the Chancellor couldn’t resist making a reference to Liz Truss’s mini-budget, blaming it for the mortgage woes.

The reality is that it was Covid-19 and Russia’s war on Ukraine that sent inflation and interest rates soaring in Britain and across the Western world.

In fact, the US Federal Reserve has not yet lowered rates, and in Japan they are raising them.

As for mortgage repairs, they were down a full point from their peak before the Bank acted and there should be more to come.

This could do more to boost housebuilding than Deputy Prime Minister Angela Rayner’s determination to exploit the green belt.

Bailey has maintained for some time that UK (and European) inflation has been supply-driven, so the path to lower rates is easier to chart than in the US, where consumers refused to stop spending.

At the August session, the Governor did as he was asked and led from the front, supported by a group of Bank insiders, including new Deputy Governor Clare Lombardelli.

LSE associate professor Swati Dhingra has been heard calling for rate cuts for months.

She has rightly argued that monetary policy needs time to be effective.

References to the “persistence” of inflation by the most hawkish members of the Bank’s interest rate setting committee are worrying.

They may fear that the Reeves effect of generous public sector pay deals could lead to a wage spiral.

Bailey may have dismissed this too easily. On the positive side, he argued that current tension in the Middle East was less likely to lead to skyrocketing fuel prices than in the past.

After former US Federal Reserve Chairman Ben Bernanke debunked the Bank’s forecasting model, it is hard to take its modelling ability seriously. The prediction of the longest recession known to mankind first turned into an average growth forecast of 0.2% for 2024 and has now been revised upwards to 1.25% (still too negative).

Even less explicable is the prediction of 1 percent output growth by 2025, which is well below the Office for Budget Responsibility’s spring forecast of 1.9 percent.

It does not take into account the momentum generated in the first half of this year.

You only have to look at the string of upbeat earnings reports just published by leading engineering companies Rolls-Royce, Shell, the London Stock Exchange and Barclays (and the dividends and share buybacks that have followed) to recognise that optimism is returning after the major crises of the last decade.

If the Bank is to fully restore its growth trend of 2 to 2.5 percent, it must relax its policies and continue to cut.

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