Why interest rate cuts just don't work any more

Yet credit has not got easier. The headline rates from some of the mortgage banks were cut by a quarter-point along with Bank Rate, but the impact has been more than offset by factors beyond the Bank's control.

Borrowing is getting harder and more expensive. If you want a 100% mortgage, you can still find one, although there's not much choice, and the rate will be punitive. Most lenders have trimmed their maximum loan-to-value; a cut from 95% to 90%, for example, means the borrower must find twice as much cash to buy his house.

The banks have not suddenly become even more greedy, but they need to charge more to rebuild their damaged balance sheets. The shocking results from Bradford & Bingley and Alliance & Leicester this week are bad news for shareholders and borrowers. The MPC can see this, which is why all members agreed on the need for a cut this month.

The bigger fall demanded by David Blanchflower might have smacked of panic, and risked making the lenders even more cautious. Besides, it's clear that inflation is also rising strongly. It's seeping from the supposedly benign area of rising asset prices (houses, shares, artworks etc) into the more essential areas of everyday life.

A pint is nudging £4, the cost of a cuppa is about to rise, while cocoa is up 45% in a year, with arabica coffee beans 36% higher. The 71% rise in the price of iron ore, for the second year running, may seem sufficiently distant not to pose too much of a threat in the High Street, but steel is everywhere, and the jump merely mirrors what's already happened in almost every other commodity. Grain prices have doubled in two years, the oil price has broken through $100 a barrel, and gas prices are rising sharply.

The classic remedy for inflation is to raise interest rates, while the classic remedy for faltering growth is to cut them. Now the Bank Governor faces the prospect of writing to the Chancellor to explain why he's cut interest rates just before inflation broke out of the band he is required to target.

He may be tempted to say that there's a limit to the power of Bank Rate; as Kate Barker, a key member of the MPC, put it this week, the benign economic conditions that have characterised the past decade are coming to an end. The central banks can keep cutting, but they have less and less impact on the price of money in the market.

Just as the old post-war demand stimulus from increasing Government deficits became progressively less effective through each cycle, we are finding some of the limits of what can be achieved through central bank intervention. For years, economists have wondered how the massive imbalances around the globe would resolve themselves, as the the emerging countries lent the western nations the money needed to cover their deficits.

We may now be starting to find out. Rate cuts designed to stimulate growth instead push down currencies and stimulate inflation, producing stagflation, where prices go up even though there's no growth. As is already obvious in property, the borrowing party is over, and the debts have to be serviced, if not actually repaid.

Had the Government used its years of plenty to get its own finances in order, it could embark on the capital spending programme we so obviously need. Unfortunately, its balance sheet looks as bad as that of many homeowners. The Governor had better get drafting.