Why there is not much longer to wait for an interest rate cut

How soon is too soon?

That’s the question exercising members of the Bank of England‘s monetary policy committee (MPC) at the moment. All nine members know that interest rates, currently at 5.25%, will have to be cut in the coming months.

After all, high interest rates represent a brake on the economy and it’s becoming clear that keeping the brake pedal down is causing economic pain.

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Unemployment is beginning to rise; the strength of consumer demand is dropping and, most of all, inflation is coming down too.

For Bank insiders, the fact that the rate at which the consumer price index is rising each year is about (at least according to their forecasts) to hit 2% is a mark of success.

Not long ago, as prices rose at the fastest rate in decades, many in the City wondered whether the Bank might have lost control of inflation – which it is supposed to keep as close as possible to 2%.

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While the indicator’s fall is partly down to the volatility of energy prices (having been the main force lifting prices in recent years, they are now the main force depressing them), what gives the Bank’s policymakers hope is that while CPI inflation is expected to bounce back slightly in the coming months, their forecast suggests it will not exceed 3%.

The upshot is that inside the Bank there are some who are now whispering quietly that they might have succeeded – inflation might have been tamed.

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But that brings us back to that question: if inflation is tamed then there’s no need to have interest rates so high, so how soon should they be cut?

Complicating factors is what’s happening on the other side of the Atlantic, where the Federal Reserve, America’s central bank, has committed something of a U-turn.

Image: Higher US rates would tend to weigh on the pound, making imports bought in dollars more expensive. Pic: Reuters

Having guided investors and economists a few years ago that an interest rate cut was coming soon, the Fed chair, Jerome Powell, has more lately hinted that no cut was coming anytime soon.

And since America usually leads the way on interest rates, that raises an unnerving question: can the UK really begin cutting rates so long before the Federal Reserve?

The Bank’s internal assessment is quite simply that the British economy is in a very different place to America. The US is growing very strongly indeed, partly thanks to large federal spending programmes pumping cash into green tech and semiconductor manufacturing.

There is nothing analogous in the UK, whose economy is expected to grow by 0.9% over the next 12 months or so.

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That’s an upgrade on the previous 0.6% forecast, but is only a fraction of the 2%+ growth enjoyed in the US.

In the coming weeks, we’re expecting an unusually important set of economic numbers. Inflation data for April is expected to show a big fall, down to 2%. There are some jobs data and, of course, tomorrow we learn whether the UK has bounced out of its current recession (it almost certainly has).

In the end, this data is what will determine whether the MPC is bold enough to cut rates in June or in August (or, if the data shows an unexpected increase in inflation, to put those cuts off for longer).

So it’s a waiting game. But it looks like there’s not that much longer to wait.