Britain’s economy needs rate cuts sooner rather than later

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Reating-setters at the Bank of England (BoE) are a strangely awkward bunch, at least publicly. At the Federal Reserve, America’s central bank, almost all of its recent monetary policy decisions have been unanimous. That has not happened at the BoE since interest rates began to rise in late 2021. At its last meeting, on February 1, the nine-member monetary policy committee had a majority (MPC) chose to keep interest rates at 5.25%. But separate votes were cast to raise rates, keep them flat and cut them – the first such three-way split since the financial crisis.

Despite the disagreements, the argument is moving in favor of the pigeons. No longer the international fringe of high inflation, Britain still stands out for troubled growth. Elsewhere in the rich world, and to the dismay of many economists, it didn’t take much economic pain to bring down inflation. Britain seems to be less fortunate. As a result, the case for starting to cut interest rates soon, if not quite yet, looks stronger than in any other large rich economy.

Until recently, inflation was the main macroeconomic concern in Britain. “Core” inflation, which excludes volatile sectors such as food and energy, hit a year-on-year peak of 7.1% in May last year, months after a recession began in most advanced economies another. The policy imperative was clear: raise rates.

Photo: The Economist

The medicine seems to be working. Year-on-year inflation eased back slightly in December, to 4%, but much of that increase was due to increases in airline and hotel prices that are unlikely to be repeated. By some measures inflation is now within striking distance of BoEand a 2% target (for example, by calculating inflation every six months, a measure that moves faster than the 12-month change usually used; see the table below – high).

A continued slowdown is likely for a number of reasons. First, the biggest supply-side trends of recent years have eased: European natural gas prices are back near pre-pandemic levels and global shipping reserves have to subside (recent turmoil in the Red Sea aside). Second, financial markets in Britain have remained tight, avoiding the bleeding that has raised some concern in America about re-accelerating inflation. The S&P The 500 index of American companies has gained nearly 20% since November; the FTSE 100, its equivalent in Britain, is up about 4% over the same period.

But the most promising reason for the decline in inflation is the least welcome: Britain’s growth remains very weak. Britain GDP has increased by around 1.5% since 2019, half the figure for the euro area over the same period and a fifth for America (see chart below). Discussion of the country’s growth malaise often focuses on structural defects such as weak productivity growth and underinvestment. These problems have not gone away. But the evidence suggests that a cyclical economic downturn is also underway.

Admittedly the data is worse than usual; the Office for National Statistics freely admits that the reliability of economic numbers has deteriorated since the pandemic as response rates to its workforce surveys have fallen. But look closely, and a pattern of persistent weakness emerges. In December, retail sales adjusted for inflation hit their lowest level since the height of the pandemic. Business output has fallen in recent months; vacancies continue to decrease. The BoEthe commentators have penciled in zero GDP growth in the first three months of this year. Of the 61 forecasters surveyed by Bloomberg, a data provider, not one has a projection higher than 1% for 2024; the average is just 0.4%.

The solutions to Britain’s structural growth problems tend to be slow, complex and elusive. Navigating a cyclical recession is an economic area that is best trodden on. The classic solution was to cut interest rates, and to do so in addition to the cuts required by falling inflation. That moment has not yet come. Inflation remains uncomfortably high. The March budget may see a fiscal boost from pre-election tax giveaways.

A cash discount would be a much more sensible form of incentive. Only one MPC member, Swati Dhingra, voted for rate cuts on 1 February. It looks like there won’t be a unanimous break in the near future. But it may not take too many meetings for Dr. Dhingra to be in the majority.

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