A cut too far

So the Bank of England has gone ahead with another headline grabbing interest rate cut. Committee members must know something about the inflation rate that is not yet in the public domain.

The nine members of the Monetary Policy Committee that sets interest rates is always given a provisional figure for the inflation rate in the previous month and the final figure is released a few days later. It will make interesting reading.

December’s fall, heavy though it was from 4.1% to 3.1%, was less dramatic than the markets had hoped but it is quite possible that the January figure will more than make up for that minor disappointment.

Economists are now talking about the possibility of negative inflation rates, in other wards falling prices, in the next couple of months. Given the cuts in most mortgage rates, despite the reluctance of the banks to pass on the Bank of England reductions in full, it is certainly likely that the Retail Price Index, which includes mortgage costs, will drop below zero for the first time since 1960 and may already have done so. It was already down to 0.9% at the end of 2008.

The Consumer Price Index, excluding as it does mortgage payments, is less volatile but I would like to bet that it will have dropped to the 2% target in January. By March or April we could well see the Governor of the Bank of England having to write to the Chancellor of the Exchequer to explain why inflation has fallen more than one percentage point below the target less than a year after he wrote a similar letter explaining why it had shot above the upper level.

One restraint on inflation falling further has been the fall in the value of the pound, which has forced up the price of imports. It is notable that sterling actually edged up on the day that UK bank rate fell to its lowest level ever. Forex markets had assumed a half point cut so the effects had already been factored into traders’ calculations.

There is good reason to assume that sterling has bottomed out. Speculators who saw the pound struggling and, not surprisingly, bet on it falling are now squaring off their positions, which puts upward pressure on sterling. Meanwhile overseas manufacturers, services and raw materials suppliers are seeing their markets fall away and will find it hard to raise their prices.

Even if prices rise, the sharp increases in inflation caused by the soaring price of oil, raw materials and food that plagued us in the middle of last year will gradually drop out of the annual calculation. In other words, prices can rise and yet the annual rate of inflation will fall.

Cuts in interest rates are understandably being seen as irrelevant to the current situation. I have remarked before that savers are being screwed into the ground and we are reaching the point where it is hardly worth putting money away for a rainy day. (Let me declare an interest, as they say in the House of Lords, and admit that I have reached the age where my mortgage is tiny and my savings are greater than my debts.)

Furthermore, it is hardly worth the bother of reducing debts, though the avarice of credit card issuers means that clearing arrears on plastic should be a top priority for any consumers who fail to pay of the full amount each month.

Interest rate changes take months to feed through into the economy, particularly since mortgage providers started pushing fixed rate mortgages and instituted annual changes in the payments required on variable rate mortgages. We have probably reached the point when the latest cuts will start to have an effect just as the economy changes so they will be the wrong medicine at the wrong time.

With house prices still well down year on year and mortgages hard to come by, the housing market will remain depressed for the rest of this year at least. Businesses are sacking staff rather than expanding and will be wary of borrowing. In any case, lenders have reached the point where they cannot cut lending rates further without seeing their supply of cash dry up. What good, then, is cutting interest rates?

Potential homebuyers who are able to lay their hands on a fixed rate mortgage may find that this is their best chance to buy. And despite the volatility of the stock market, it is becoming more attractive to take a modest punt rather than leave cash to rot in the bank.