Despite the rate cut, inflation remains a danger

The Bank of England’s Monetary Policy Committee (MPC) has just voted to cut interest rates to 3.75 per cent and in doing so has delivered the Chancellor an early Christmas present. The five to four decision brings rates down to from the 4 per cent they’d been held at since August. The cut is the fourth this year and means base borrowing costs are now at their lowest rate since February 2023.

The cut has happened because swing voter and Bank Governor Andrew Bailey switched his vote. Markets had anticipated the move, with trades implying a cut had 90 per cent odds. However, the fact the decision swung on a knife edge shows how the MPC is still concerned about the inflation that their previous decisions had allowed to spin out of control. 

Those fears linger for four of the MPC’s members despite yesterday’s surprisingly good news that inflation has fallen much further than economists had anticipated, from 3.6 per cent to 3.2 per cent. The reason the four members continue to hold out is because British inflation remains an outlier in Europe and the G7 and that the long term picture for inflation is not a good one.

Rachel Reeve’s policy decisions on business taxes and minimum wage are embedding high labour costs with no productivity boost to make the pay hikes worthwhile. Meanwhile, British businesses and households continue to pay more than anywhere else in the world for energy. While that remains the case it’s near impossible to see how we could sustain the 2 per cent inflation target.

But the majority of the committee have overlooked those concerns – perhaps unwisely –  because of the abysmal jobs market and GDP statistics released by the Office for National Statistics over the last couple of weeks. The news that the economy is shrinking was compounded by rising unemployment and the continuing jobs collapse. 

Reeves will be glad of the boost the rate cut will hopefully give the economy but unless she, and the government as a whole, can address the long term structural issues we face then the thin line the Bank must walk between keeping inflation under control without completely stifling the wider economy will remain desperately tricky.