Minus one quarter of one percent

As expected, the MPC has cut the UK base rate from 5.50% to 5.25% today. In the context of rising energy and food prices, this sends a mixed message to observers. Why would the Bank allow an expansionary monetary policy in the context of rising inflationary pressure?

The UK service sector (which accounts for over 70% of the economy) has recently reported stronger than expected growth - but there are still low expectations regarding the future. After a difficult Christmas on the high street and a slowdown in the housing market, years of debt-fuelled consumer spending are beginning to look excessive as consumption becomes increasingly based on income rather than wealth. With fiscal policy increasingly constrained both in theory and practice by the Code for Fiscal Stability , perhaps the only option remains in cutting base rates to boost demand.

But what about inflation? Economics students who have seen the Phillips Curve will appreciate the policy conflict inherent in trying to both limit short-run growth (to control inflation) and maintain short-run growth (to create jobs). Periods of low inflationary growth create economic golden ages where ‘fine-tuning’ appears to keep the economy on an even keel. But what about when both inflation and slower growth occur simultaneously? Without a range of policy instruments available, something has to give.

Lower base rates should also weaken sterling (although the impact of the expected 0.25% cut may already be priced into the FOREX market) which will increase the price of imported goods in the UK, adding to inflation concerns. Conversely, strong sterling in recent years has helped to keep inflation low, but at the expense of a widening current account deficit.

What can be done? The advice usually given the morning after the night before springs to mind - we shouldn’t have had such a great party in the first place. But I think we’ve known that for a while.