The first cut is, they say, the hardest. As the cheers for last week’s cut in interest rates by the Bank of England fade, the good news first. Interest rates are now set to fall a long way – very likely to 4 per cent, and perhaps below, by 2009.

The bad news lies in the reasons behind this impending slide in our borrowing costs.

Not only is the economy now facing a rougher ride in the next year or more than many have yet accepted, but, crucially, as the Bank attempts to counter this with further cuts in rates, these are likely to prove a less potent remedy than in the past.

The two key forces generating the downturn that is taking hold – the housing market and high street spending – are well understood.

In the housing market, prices now seem certain to stagnate at best next year, and will probably see outright falls. While this need not be such grim news as it is often painted, will hit consumers’ confidence and willingness to spend, as well as their readiness and ability to borrow, hard.

Households are, at the same time, feeling a severe pinch from weak growth in incomes, soaring fuel and food prices, and past rate increases. There are already clear early warning signals of the toll on demand from wilting confidence and squeezed spending power.

Until now, the Bank’s nagging worries over inflation have meant that it has been cautious in responding. This will probably now change quickly as growth falters and these understandable anxieties fade along with many of the persistent price pressures. Yet the Bank’s nasty inflation headache looks likely to be replaced with a different one – that the cuts in interest rates it will have to make prove less effective.

At the heart of these problems is that the long economic expansion of the past 15 years has been built on debt. We don’t need to be Micawberish about it: borrowing is vital to the functioning of a modern economy - up to a point.

Yet as as the good times rolled, Britain kept on borrowing, remaining in the grip of a “to hell with tomorrow” culture of spend today, worry later.

Now that harder times are here, our collective failure to set aside a few pennies for a rainy day may well mean that we turn out to have been living on borrowed time – as well as borrowed money.

With this binge about to end, and a global credit crunch biting, both Britain’s borrowers and lenders look pretty stretched. So the challenge that the Bank may face next year as it attempts to bolster demand with lower base rates is that nervous and overextended households may be reluctant to carry on borrowing, while stressed and overleveraged banks may be reluctant to lend.

The last time that the economy faced a serious threat, at the turn of the decade, the Bank’s response was to pump up consumer demand with cheap money – cutting base rates all the way to 3.5 per cent.

The Bank knew well that this risked a build-up of excessive personal debt, but it argued rightly that the alternative was a painful downturn.

Yet now the same pragmatic strategy seems unlikely to work again. Households have already taken on a £1.4 trillion debt mountain, and have been spending almost all of their disposable income. In meaner times, and with house prices sliding, it seems improbable that many will be so reckless as just to carry on as before.

If households will be more wary of borrowing, they may be all the more reluctant to do so at the rates at which banks can and will lend.

Britain’s banks are now struggling to borrow even from each other as the financial system absorbs vast losses from reckless lending to US sub-prime homebuyers. With money thus scarce in the credit markets, its cost is climbing. Even as the Bank eases official base rates, effective interest rates in the money markets on which the commercial banks depend are driven far above that – by as much as a full percentage point.

With the credit losses suffered by City institutions still multiplying, these strains look set to persist, and grow worse. Significant economic effects will then be felt as banks resort to toughening lending conditions, and even some worthy borrowers find loans harder to obtain, and more costly if they can be had at all.

Companies – the one part of the economy that is cash-rich rather than borrowed to the hilt – are better placed to borrow, so investment spending is at least potentially an alternative growth engine. Yet businesses are unlikely to see much merit in paying elevated loan rates to invest in a stumbling economy.

As the MPC contemplates the worrying reality that interest rates may not be the panacea they have proved in the past, its collective headache will be made all the worse by the knowledge that the Treasury’s alternative medicine cabinet – the fiscal policy remedies of tax and spending changes – has already been emptied by Gordon Brown.

Since 2000, the Government has been just as guilty of reckless borrowing as any household. Back then, as the economy faltered, Mr Brown was able to borrow to fund a spending spree that helped keep us out of recession.

His legacy to his successor, however, is government finances that are stuck deep in the red, with public borrowing still at 3 per cent of GDP, even after a long run of buoyant growth. With the deficit set to climb still higher as tax revenues are hit by next year’s slowdown, Alistair Darling has little or no room to boost spending or cut tax to shore up activity.

Both the Chancellor and the Bank must now fear that, if Britain has been living for too long on the never-never, the price now may be a lot higher than the APRs in all those loan commercials and leaflets suggested.

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