Bank of England must cut rates quicker to stem trade war fears

Telegraph

03-05-2025

A 0.25 percentage point rate cut next Thursday to reduce the Bank Rate to 4.25pc is close to a done deal. But that would still keep the rate above the 2.8pc average since the bank became operationally independent in May 1997.
It would mark the fourth cut since policymakers started to ease the brakes in August 2024 and maintain the pattern of lowering rates at a pace of once per quarter at meetings when the bank publishes its Monetary Policy Report and the governor hosts a press conference.
So far, the Bank has kept rates unchanged at interim meetings – including at the last one in March.
The critical question for Thursday is not whether the Bank will cut, but whether it will have the courage to signal that it plans to accelerate future cuts as a precautionary measure against rising growth risks.
At the start of the year, economic logic argued for the Bank to stay in the slow lane. Growth momentum seemed to be picking up, and the UK had not fully gotten over the bitter inflation shock of 2022 and 2023.
And even though the Bank had expected inflation to return close to its 2pc target within two years, inflation looked likely to jump above 3pc for a period this year because of a temporary rise in energy prices. Plus, the combination of weak productivity growth and elevated wage pressures tilted inflation risks a little to the upside over the medium term.
That was then. Now, the situation has changed, and the danger is that policymakers get caught offside worrying too much about the last shock instead of the current one.
To its credit, the Labour Government has reacted to US tariffs by avoiding retaliatory measures and instead by temporarily cutting tariffs across a range of imports. Thanks to such action, as well as broader global developments, trade wars are likely to be a disinflationary shock for the UK.
A diversion of cheap Chinese goods into Europe, lower global commodity and energy prices reflecting weaker global demand, and lower import prices thanks to sterling's steady appreciation will help to keep a lid on price pressures. Furthermore, the fear factor coming from increased uncertainty may even dampen wage and price setting – softening underlying inflationary pressures.
Judging by these fundamentals, the Bank should be safe to move a bit more quickly with rate cuts from now on.
Ideally, policymakers should complement a likely cut on Thursday with a strong signal that they intend to reduce rates further in each of the remaining five meetings for the year. That would take the Bank Rate to 3pc by year-end instead of 3.75pc – which is where it would end up if policymakers keep the pace of cuts unchanged.
Judging by the near-textbook response of the economy to the rise in the Bank Rate from 0.1pc in December 2021 to 5.25pc in August 2023, cuts of 1.5 percentage points rather than 0.75 percentage points could radically improve the outlook.
Fears of a recession or even financial crisis, which had been widespread at the start of the tightening cycle, proved far overblown.
Instead, slowing demand – linked to softer credit and real estate momentum – helped to curb earlier inflation and wage excesses. Initial worries about what would happen if the Bank slammed the brakes hard, as it did, overlooked the fact that the financial health of the private sector is robust.
Household credit and mortgages versus incomes are at 30 and 20-year lows, respectively, and the household saving rate sits at a lofty 12pc. Corporates' debt is at a near-30-year low versus GDP while their cash balances are worth some 20pc of GDP. Banks are well capitalised.
More aggressive easing would help to turn these buffers against shocks into springboards for growth. Importantly, it would stimulate domestic-oriented services and consumer sectors as well as housing – offsetting the external drag.
Yes, government finances are a mess, but the private sector has the capacity to leverage up and spend. The problem is that, after years of unusual and repeated shocks, businesses and households find themselves in a state of near-chronic pessimism.
Paradoxically, the fear of tough times ahead risks becoming self-fulfilling again if the response by companies and consumers is to tighten up.
The major problem with monetary policy is that it is a blunt tool. But when people need a big nudge to go out and spend, invest, and borrow, it is the right instrument for the job.
The question now is not whether the Bank has the power to change the narrative, but whether it will use it.