Looking for lift-off

The Bank of England wisely, and predictably, reduced interest rates by 0.25% to 4.5% yesterday thereby providing both a mild stimulus for flagging consumer spending and slightly lower mortgage interest payments to soothe the housing market. Whether this will be the first of a series of cuts will depend on what effect it has on the underlying growth of the UK economy which is distinctly underperforming the official forecasts. In his budget, Gordon Brown, the chancellor, set down a target growth rate of 3% to 3.5% for 2005. On the basis of what has happened in the first half of the year, the economy will be lucky to expand at 2%, a level that can't be good for Mr Brown's worsening budget deficit.

All this needs context. The fact that in this cycle interest rates - before yesterday's reduction - peaked at only 4.75% is remarkable. It is the lowest peak for 50 years, thanks to low global inflation coupled with stable monetary and fiscal policies in the UK of a kind never previously associated with Labour governments. Growth of 2% is also respectable compared with other European states. It means that the economy is - so far - well clear of any danger of sliding into an actual recession (negative growth) of a kind that the previous Conservative government culpably brought about twice in one decade. The trouble is that 2% is not what was forecast and if the economy continues to grow below its potential then unemployment will rise steadily and tax revenues will fall so short of what is needed to balance the books that taxes will have to be raised or spending cut.

Economic indicators are giving conflicting signals. Unemployment - using the standard international measure - is going down but the number of people claiming unemployment benefit is going up. Retail sales were depressed for five months until May but suddenly bounced back in June (the month before terrorist bombs sapped confidence in London). Manufacturing industry is experiencing negative growth instead of expanding by 2.75% as laid down in the budget. However, new housing orders in the private sector were 24% higher in the latest quarter than a year ago, according to figures published yesterday.

This growth is, of course, from a pretty low base and won't give the housing market the supply-side boost it needs to satisfy frustrated demand. A cut of 0.25% ought to be good for first-time buyers because it could be the start of further cuts. But buyers have to decide whether house prices, which rose unexpectedly and undeservedly by 15% last year, have further to fall before they reach a new equilibrium. The Council of Mortgage Lenders yesterday revised its previous forecast of a rise of 4% in house prices in 2005 to a fall of 2%. A dramatic drop - which is not likely on present evidence - could have serious knock-on effects on consumer spending.

What is happening in the economy is that continued strong expansion of public spending, construction and parts of the service industries (such as finance and the City) is not enough to make up for the poor performance of exports, manufacturing and consumption. Once again the UK will be hoping that the US cavalry will ride to the rescue. It may do just that. After stalling earlier in the year the US economy is now expanding again at an annual rate of around 4%. There are even signs of renewed economic life in the battered eurozone - which may explain why the European Central Bank left interest rates unchanged at 2% yesterday for the 26th consecutive month. The government hopes that an upswing in the international economy and a fall in sterling will boost UK growth from 2% to somewhere nearer the 3.25% target. This probably makes another interest-rate cut less likely in the immediate future. But the Bank shouldn't move its foot too far from the accelerator just yet.