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As recession fears fade following strong services PMIs, was the Bank of England wrong to cut interest rates post-Brexit?

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Surveys suggest that Britain will avoid recession (Source: Getty)

Andrew Sentance, senior economic adviser to PwC and a former member of the Bank’s Monetary Policy Committee, says Yes.

Very low interest rates have been with us since 2009, but the Bank of England’s latest stimulus package has had a dramatic impact on long-term investment returns.

Twenty-year UK government bond yields are now just over 1 per cent, less than half of the returns available at the start of this year – and this is hitting pension funds and other long-term investments. The latest PwC estimates are that pension fund deficits have widened by £100bn over the past year – to £700bn, about £26,000 per UK household.

The policy of ultra-low interest rates is now doing more harm than good. Financial markets have given up hope that UK interest rates will rise in the near term, and long-term returns on government bonds have collapsed. Yet this is just the time when working people need to be encouraged to save more to provide income in old age as life expectancy increases. The latest economic indicators suggest this latest interest rate and QE package was not needed, yet it has done serious damage to long-term investment returns.

Scott Bowman, UK economist at Capital Economics, says No.

For a start, the nature of these surveys means that the services PMI probably overstated the rebound in activity in August, just as it overstated the drop in July. Small rises or falls in activity by a large number of firms can cause big movements in the PMIs.

What’s more, the cut in interest rates actually contributed to the August recovery. The services release noted increases in export activity and domestic tourism related to the drop in the pound, which has been partly due to lower interest rate expectations. Meanwhile, the fact that households haven’t cut back on spending too much partly reflects lower interest rates.

Finally, other than hitting savers, the potential cost of the cut is small given inflation is currently low. Overall, the UK will probably avoid a full-blown recession. But this doesn’t mean that the Bank of England was wrong to lower interest rates. Instead, policy easing is one of the reasons why a deep recession should be avoided.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

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