Happy days are here again! This was the headline over an article I wrote in the aftermath of Black Wednesday in September 1992, when Britain was expelled from the European exchange-rate mechanism and most people assumed the economy, along with the Major Government and the pound, had fallen off a cliff. It seemed to me, by contrast, that Black Wednesday had suddenly given Britain’s monetary authorities the freedom to cut interest rates more rapidly than almost anyone imagined possible – and that was exactly what the Government, which in those days controlled monetary policy, did.

The result was a rapid economic recovery, followed by 16 years of uninterrupted noninflationary growth.

Three weeks ago I wrote that the Government and the Bank of England faced a similar challenge, and opportunity: that interest rates could be reduced, without any risk to inflation, to 3 per cent by Christmas and eventually to around the US level of just 1 per cent.

The best way to begin this process – and to bolster British businesses, homeowners and consumers with the reassurance that monetary relief was on the way – was to cut interest rates by a full percentage point on November 6. When I wrote those words it was more in hope than in expectation, but in the event the Bank has done even more than the boldest advocates of monetary reflation had hoped.

Yesterday’s sensational cut has reduced interest rates in one fell swoop to the lowest since the 1950s. It means that, for the first time since the aftermath of Black Wednesday, Britain is paying less for its money than the eurozone. And, most importantly, it implies that the Bank will use to the full its freedom to keep cutting interest rates until economic recovery is assured.

The implication, given that our economy is even more dependent than America’s on housing and finance, is that British interest rates will indeed fall to the level that everyone agrees is now appropriate for the US economy – 1 per cent or perhaps even less.

The prospect that the Bank is willing to use its firepower to the utmost does not mean that the recession is suddenly over.

Indeed it has only just started. Unemployment will keep rising and house prices will keep falling for at least the next 12 months. And credit will remain hard to get and surprisingly expensive, as banks exploit low interest rates to boost their capital, rather than pass on to borrowers the full benefit of lower interest rates. However, over time, the profit opportunities presented by ultra-low interest rates will prove irresistible to borrowers and to lenders, and normal credit growth will revive. And the more boldly the Bank acts in cutting interest rates, the sooner normality will return.

Yesterday the Bank’s boldness exceeded all expectations. As a result, the nightmare of a deep and prolonged economic depression will remain just that – an imaginary horror, rather than a realistic prospect.

This, in turn, means that the Bank will recover its reputation for competence and deserve to retain its operational independence, which had served the country so well in the past decade but had begun to be challenged by responsible politicians in all parties after the debacle of Northern Rock. Even more importantly, the Bank’s willingness to set monetary policy in the national interest without worrying about the weakness of sterling in the past few months means that Britain will enjoy the full benefits of keeping its own floating currency, independent of the euro, while the continental countries bicker about their stability pact and the timidity of the European Central Bank.

All in all, a good day’s work for the Bank of England. And for Britain, a happy day indeed.

A BALANCING ACT

What are interest rates? Why does it they matter?

Official interest rates set a floor for the cost of borrowing money for consumers and businesses. This is the main tool for steering the economy, alongside government tax and spending

What target is used to set rates?

The Bank of England sets rates to try to keep consumer price inflation on track to stay as close to 2 per cent as possible over the following two years. Provided that it does so, the Bank will also set rates to help to secure stable economic growth

How do interest rates affect the pound?

Cuts in interest rates generally push the pound lower, although there can be exceptions. A cheaper pound helps to boost exports, but also makes imports more expensive, adding to inflation

Why is inflation no longer a problem?

Inflation has been a big headache for the Bank, reaching 16-year highs of more than 5 per cent. But it is now set to fall sharply as the recession means that businesses will not be able to make higher prices stick, workers will not be able to secure higher wages and tumbling demand for oil and commodities means that the cost of these is also plunging, further reducing price pressures

Explore Economics

• Pre-Budget Report 2009

• Budget 2009

• World Economic Forum

• The Times MPC

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive