The Bank of England has acted. The monetary policy committee agreed to shave 0.25 base points off what was, at 0.5%, already the lowest continuous rate in the Bank’s 322-year history and interest rates have been set at a new low. The markets may have expected it, but it still looks a dramatic response to an uncertain future that has been made more perilous by the post-Brexit shock. The Bank’s governor, Mark Carney, warned that the economy would be likely to be 2.5% smaller in three years’ time than it would have been without Brexit; unemployment could be as much as 250,000 higher. Some analysts think he is being optimistic. Seven years ago, when interest rates fell to 0.5%, no one expected them to go lower, let alone for the economy still to be bumping along the bottom with both wage growth and productivity in intensive care; Mr Carney’s declaration that the whole package will stimulate lending and encourage investment sounded like an eerie echo of his predecessor Sir Mervyn King in 2009: “it will work in the end”.
What’s different this time is the impact of Brexit on a recovery that was already faltering. For the ordinary punter, the Resolution Foundation helpfully set out the real impact of the latest forecast, factoring in the consequences of the leave vote. It reckons that by the end of 2018, the economy will be £45bn smaller than previously thought, prices 1.1 percentage points higher, real earnings down £615 and real household income down £680. Pensioners and savers will feel the pain even more. In his defence, Mr Carney pointed out that they, like everyone else, need the economy to prosper.
This may not even be the end. There could be one more squeeze on the base rate without sinking into negative territory, where Mr Carney clearly would prefer not to tread. He believes that the way the package is structured, banks will have no excuse for not passing on lower rates, nor lending more freely. But there is now no doubt that the Bank is at the limit of its effective policy reach, nor that it may not have done enough to reboot the economy. It has bought the government some time. That parks the argument on the steps of the Treasury. There was no hint on Thursday of the thinking on the best way for the new chancellor, Philip Hammond, to meet Theresa May’s commitment to reshape the economy. The kind of dramatic cut in VAT that John McDonnell, the shadow chancellor, has proposed is one option. It would lift the spending power of the lower paid, who feel the tax’s regressive impact most keenly. It might be a good short-term stimulus.
But to make the wider economy more resilient the money would be better invested in infrastructure. Better still might be to treat investment in human capital as another aspect of infrastructure spending. Low productivity and stagnant wages have been a drag on growth for the past decade. Improving Britain’s skills base by investing in the cash-strapped further education sector; picking up the bill for apprenticeships and vocational training rather than offloading it all on employers; supporting technical training at schools, either through the embryonic university technology colleges or some other model that fits the secondary education landscape more neatly; maybe even reconsidering tuition fees and student debt – these are all ideas that could ease the deep intergenerational injustice that has been so exacerbated by booming asset prices. The government could also make a virtue out of bailing out the NHS, which is sliding into the worst financial crisis in its history. Investing in a change programme that made a reality of local councils’ health promotion duties, as well as training more doctors and nurses to prepare for the possible consequences of Brexit are necessary preconditions for a health service that is fit for its eighth decade.
The coming weeks, between now and the autumn statement, will be the new government’s first big test. If it really means to be different, it must start now.
