Where do the rate cuts end? Not where they started

The Bank of England has cut its base rate for the first time in four years. The journey back down will be a lot slower than it was up, says Edmund Greaves, editor of Mouthy Money.

The Bank of England has ended the biggest ‘will they/won’t they’ since the finale of Friends.

It has cut its base rate down to 5% – a measly 0.25% cut. The decision was also finely balanced with 5-4 in favour of a cut.

The message from the Monetary Policy Committee is clear – the route down is going to be softly and slowly. A big departure from the big squeeze it undertook when hiking in 2022-23.

But where do the cuts end? Are we set to return to the mind-bogglingly-low rates of the 2010s?

The natural rate

What the Bank of England has to figure out is what is called the ‘natural’ or ‘neutral’ rate of interest. This is an ideal policy level in which the economy doesn’t grow too quickly (overheating and causing inflation then a crash) or too slowly – leaving everyone not better off.

Essentially it neither overstimulates nor restricts economic activity. But in practice finding this natural rate is tricky.

What is curious is the bank is cutting rates despite the fact that wages are growing strongly and GDP is ticking up better than expected. This suggests they’re now pre-empting a situation where rates are too high – which is liable to ultimately lead to unemployment and an economic crash.

All things being equal the natural rate of interest will be above 2010s standards, but potentially not that much higher.

So while we shouldn’t expect a return to the era of cheap debt any time soon, barring another bout of inflation we should expect rates to gradually reduce to a level which households, businesses and the economy at large find more accommodating.

Hopefully then, this is good news today. Although for many with mortgages on high rates or renewing, it might not feel it. Better times (tax hikes aside) lay ahead.

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