Why I am not celebrating the pre Christmas interest 0.25% rate cut

The Bank of England’s decision to cut interest rates just before Christmas has been greeted with festive cheer in some quarters. I am not among them. In my view, the Monetary Policy Committee should have held rates steady.

My concern is not just about inflation risks and rising global price pressures. It is also about credibility. After a series of past mistakes, capped by last month’s disastrous Budget statement, the UK’s economic policymaking reputation is already fragile. This was a moment for the Bank to reinforce its inflation fighting credentials. Instead, it chose the easier headline.

There is also a deeper problem with the logic behind the cut. The familiar idea that lower interest rates automatically lead to stronger consumer spending and faster GDP growth no longer holds. That relationship, once a staple of economic commentary and still repeated in much of the coverage of the MPC’s decision, has largely broken down.

Why I am not celebrating

Before Thursday’s meeting, the case for another cut seemed straightforward to many. Economic growth has been flat or negative for four months, unemployment is at a five year high and there was pressure on the MPC to act. Since August 2024, the Bank’s policy rate has been cut five times, from 5.25 percent to 4 percent. Last week’s decision took it down again to 3.75 percent.

Supporting growth is a worthy goal, but the MPC’s primary duty is to control inflation. That responsibility is even more important now, as international investors who buy billions of pounds of UK government debt each month are becoming increasingly sceptical.

The UK is not the United States. Sterling is not the world’s reserve currency. Yet the MPC increasingly behaves as though it has adopted the Federal Reserve’s dual mandate, balancing inflation against growth and employment. With UK inflation at 3.2 percent in November, well above the official 2 percent target and higher than most G7 peers, the Bank should be singularly focused on bringing prices under control.

Rate cuts make for positive headlines. They can give stock markets a short term lift and hand the government a convenient talking point, even though ministers should not be taking credit for the actions of an independent central bank. But the structure of the UK economy has changed in ways that blunt the impact of lower rates.

The traditional transmission mechanism ran through mortgages. Cheaper borrowing reduced monthly payments, freed up household income and boosted spending. That mechanism is now badly weakened.

In the early 1990s, nearly half of UK households had a mortgage. Today, it is fewer than 30 percent, a consequence of chronic housing shortages and affordability problems. In 1997, when the Bank gained independence, 68 percent of people aged 35 to 44 had a mortgage. Today, that figure has collapsed to 32 percent, leaving millions of younger adults locked out of home ownership at a crucial stage of life.

The nature of mortgages has also changed. In the 1990s, around 80 percent were on variable rates, meaning Bank of England decisions fed directly into household finances. Now, roughly 80 percent of mortgages are fixed rate. That means a cut in the policy rate delivers almost no immediate boost to consumer spending.

Even when lower rates eventually affect remortgaging and new loans, the number of households involved is far smaller than in the past. The link between Bank rate cuts, consumer demand and GDP growth has effectively been severed.

The narrow vote that delivered the latest cut only adds to the unease. The MPC split 5 to 4 in favour of reducing rates, reversing a 5 to 4 decision to hold in early November. The decisive change came from Andrew Bailey, the Bank’s governor.

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That matters because Bailey was the same governor who spent much of 2021 insisting inflation would be transitory, even as warnings mounted about a post pandemic surge. Inflation was not transitory. By December 2021, it had reached 5.4 percent, a 30 year high, well before the war in Ukraine escalated. The Bank did not raise rates from their emergency pandemic level of 0.25 percent until then.

That failure was serious enough for Bailey to commission an external review by former Federal Reserve chair Ben Bernanke into the Bank’s forecasting errors. Against that backdrop, the decision to cut rates again while UK inflation remains well above the eurozone average of 2.1 percent, and service sector inflation is still running at 4.4 percent, looks reckless.

We gain very little from this cut, given the weakened transmission mechanism. What we risk losing is credibility.

Yes, many economists supported the decision. But many of the loudest voices are City economists who welcome rate cuts almost by reflex, especially when they deliver a pre Christmas boost to markets and bonuses. A number of serious thinkers I speak to privately believe the MPC bowed to political pressure.

The bond market tells its own story. Ten year gilt yields, the true benchmark for mortgage and corporate borrowing, have risen sharply since August 2024, even as the MPC has cut rates by 1.5 percentage points. That divergence signals market distrust in the Bank’s inflation outlook.

Even on the day of the cut, gilt yields rose, then climbed further after news that government borrowing was £10 billion higher than last year over the same period.

The government appears convinced that growth will come from more borrowing and more spending. That belief is deeply misguided. It is not the job of the Monetary Policy Committee to accommodate it.