Hamish McRae: Now we're out of rate ammo, we just have to watch and wait

Economic Life

So that's that. The Bank of England has put paid to any suggestions that it is "behind the curve" as far as interest rates are concerned. True, there have been calls to cut rates even further, and I suppose that may well happen, but I don't think anyone believes that if 1 per cent base rates don't work, 0.5 per cent rates are likely to have muchfurther impact. It is tokenism. The issue is not the price of money but its availability and the willingness of people to borrow.

Availability is a huge problem because the UK banking system does not have the capacity togenerate enough credit to supply UK needs. There has been a lot of talk of the UK banking sector being too big and that could be true in the sense that we have, or at least had, a large international banking business run fromLondon, half by foreign banks. You don't want to be too dependent on any one industry, and we were. But it is not true when you look at, for example, the supply of mortgages, where foreign lenders had about one-third of the market, and Northern Rock at another 20 per cent. Take out most of that and surprise, surprise, there aren't enough mortgages to go round.

Even if there were, there is the demand side. Is it really wise to borrow to the limit possible right now? No financial adviser could tell a client to do that without risking their own necks. You have to give "best advice", and given the uncertainties it would be hard to claim this was a great idea. On the corporate side, the willingness to borrow is still there, because keeping a company alive through the cycle may depend on being able to roll over debts, or even to increase them. So you could say there is more of a supply, rather than a demand, problem there. But for personal borrowers, prudence says pay those credit cards off as fast as possible.

What happens next? The first thing is to recognise there was a very good reason why interest rates have not dipped to this level before (see first chart). It is that banks need to attract deposits. We are at a level now where people are seeking alternative places to put their money. If they choose National Savings, premium bonds or some other public medium, that reduces the fiscal deficit, but it is money not available to the banks. That is not to say this further fall in rates is necessarily a mistake; just that it is not likely to have much impact on demand.

Two things will affect demand: domestic consumption and export orders. It is easy to be too gloomy about the former. True, demand for big-ticket items such as cars is catastrophic, but that has happened everywhere in the world, from Shanghai to Seattle. True too, any product or service associated with housing is in dire trouble. Nor is it wise to regard the reported rise in house prices in January as a reversal of the downward trend; it is more likely it will be seen to be an aberration.

Still, because demand has fallen so fast, it may bounce back quite suddenly. People put off buying for a while, but eventually things have to be replaced. That does not mean the bounce will be sustained, any more than this bounce in house prices is likely to besustained – just that things never move in one direction for ever, and all our experience in Britain is that consumption is remarkably stable even in bad times.

As far as consumption isconcerned, though, all the ammunition has been fired. The monetary magazine is empty. There will be more measures from the Bank and the Treasury – the so-called quantitative or unorthodox measures – and these will be used to pump money into the economy. But these will not affect consumption directly; in the first instance they will be directed towards the commercial and banking sectors, not the personal one.

There are no fiscal weapons either, because the present boost is at the limits of the acceptable, maybe above it. Were the Government to try to borrow yet more, the very fabric of our public finances would be on the line. Technically the country would not default on its debts. Because our debts are mainly in sterling and we control our own currency, we can always print the money to pay back. It is much more likely that defaults will come in the eurozone, with Greece as the most obvious candidate, though my instinct is that this is still the best part of a decade away. Nevertheless, the fall in sterling is already far worse than in 1992, and for foreign holders of UK government debt this is something akin to a default already.

On the other hand, there are signs that the fall in the pound is starting to have some impact on demand. The economy has been tilting towards exports. This comes from HSBC, and the report associated with it comments that the fall in the pound is no panacea, which of course is right. But the fact that the rebalancing of the economy is already under way, so soon after the devaluation, is quite encouraging. Providing it does not fall too much further – or better, come back up a bit – this is helpful.

That leads to the question as to whether the UK will indeed fare worse than the other large economies this year, as the IMF forecasts. Looking at the plunging output in Japan and Germany, both heavily dependent on exports and both with overvalued currencies, don't exclude the possibility that we may come through in slightly better shape than theother G7 nations: not great shape, mind you, just not quite as bad as the rest of the pack.

Ultimately what will turn domestic consumption will be a turn in house prices. They don't have to go up; merely stop coming down. Once that happens the fear of borrowing will decline, and people with cash (yes, there are some left) will be prepared to use their borrowing capacity to gear up. While it is not realistic to expect a rapid recovery of confidence, during all past cycles, consumption has never fallen two years on the trot – it rarely falls for more than a few months. But, to be clear, that turning point is not yet in sight.

You can, if you want, play the "green shoot" game, trying to figure out where signs of recovery first appear and then projecting a turning point for the economy from that. You can get into reams of analysis about the effectiveness or otherwise of 1 per cent base rates. I think it is more sensible to look around the world and see what is happening in the major economies, because the real indications will come there. So it is the US, China, Germany, maybe Japan. I would love to be able to report any positive signs there, but for the moment there is not a lot. But let's keep watching.