ONE HUNDRED NOT OUT. The Bank of England celebrated the 100th meeting of the monetary policy committee last Thursday by cutting base rate from 4.75% to 4.5%. This reduction was welcome. Growth is weak, productivity is sluggish, debt levels are high and inflation is low.

Since the pound’s exit from the European exchange-rate mechanism in 1992, Britain’s economy has enjoyed a remarkable 52 successive quarters of growth. Yet the slowdown over the past year should not surprise us — and the latest rate cut will provide only temporary relief. The economy is too imbalanced to benefit fully from lower rates. Investment and exports are not as strong as they need to be and economic growth has been driven largely by debt, which has been piled up by government and consumers.

The government looks set to keep spending as long as the chancellor has the ability to borrow cheaply or tax easily. In recent years he has spent, taxed and borrowed. A slower economy inevitably pushes up government borrowing. Yet, contrary to what many economists suggest, the last thing Gordon Brown should do is raise taxes. To tax a slowing economy compounds the problem. Instead the government will have to borrow more in coming years.

A quarter-point cut in base rate will have only a marginal impact on household borrowing, but the realisation that interest rates have peaked should itself have a significant impact in stabilising house prices and consumer confidence.

In coming months, the pound’s performance and the outlook for the world economy will have a big bearing on British interest rates, keeping them on hold. By next year, a global slowdown could push interest rates lower. Consider the key global issues the Bank of England needs to watch.

First, there is liquidity. In recent years the world economy has been awash with funds. This has led to resilience in the face of financial, terrorist and geopolitical shocks. In previous cycles such liquidity would have triggered inflation. This time it hasn’t, but it has led to a more fragile and risky financial outlook because of overvalued asset markets and over-leveraged hedge funds. Financial markets are thus far more vulnerable to future risks. Now liquidity conditions are tightening. American official interest rates have already risen from 1% last summer to 3.25% and could peak next spring at about 4.5%.

Second, there is synchronisation. Because of globalisation, the world’s leading economies are more in tandem than before. This is good when growth is strong, as last year, but it will be a problem if America slows next year. In previous cycles when America slowed, Japan and Europe took up the slack. Not now. Japan and Europe are slow-growth regions, because of demographics and inappropriate policies. Thus America and China hold the key for the world outlook. Both face challenges.

The factors that could lead to a slowdown in America are the same as those that could dent export growth and investment in China, slowing growth there. In turn, Asia and Africa could suffer. Recent years have seen the emergence of new trade corridors, as demand from China has boosted China-Asia trade and Asia-Africa trade. The good news for Asia and Africa is that any slowdown in China would probably be short-term — the longer-term trend is up.

The third issue is the dollar. Asia holds the key to the dollar’s fortunes. A decade ago, Asian central banks held one-third of global currency reserves; now they hold two-thirds, the bulk in dollars. This has allowed America to live beyond its means, easily borrowing $1.5m a minute from the rest of the world to fund its trade deficit.

The recent decision by China to allow its currency to appreciate by 2% was a watershed event. Even though the immediate economic impact on global trade and inflation will be small, the longer-term consequences will be huge and point to a future decline in the dollar’s global role. China will not just set its currency against the dollar but against a basket of other currencies. As China does, so others will follow.

In future, Asian central banks are likely to hold less of their reserves in dollars. Thus the American trade deficit will become harder to finance and other countries that have large trade deficits may also see their currencies weaken — the pound could be among those affected.

Fourth, expect competitive pressures to intensify. Although China’s currency is set to appreciate, goods from China will remain cheap. Chinese wages have been kept low because workers have been mobile, moving from rural inland areas to the booming coastal region. Now, China’s factories have become mobile. They are moving inland to where wages and costs are lower.

China is not the only country booming in the east. India is also on a roll, becoming a low-cost producer of both goods and services. And it will be running more than call centres. India wants to move into higher-value-added services.

In fact we should expect further competition across a whole range of goods. As Asian economies have become more interlinked there is scope for firms to cut costs by getting more out of the supply chain. Say a product sells for £4 in a shop, £1 of that may be production costs, which are difficult to squeeze further, £3 may be costs in the supply chain. These costs can be cut.

Of course, oil prices are high, largely because of Chinese demand. So far this has not been a problem. Many oil-importing countries were cushioned by a combination of high currency reserves, low inflation and a soft dollar. But as oil prices stay high, problems are emerging.

All this suggests significant challenges ahead for policymakers. The likelihood is that as long as American and Chinese policymakers continue to move gradually and avoid policy mistakes, the world economy will avoid downside risks and grow modestly. But these downside risks should not be underestimated.

Here in Britain, the clear message is that interest rates have the ability to act as a shock absorber, falling further when needed. Yet there is only a limited amount the Bank can do. Around the world, companies and countries are repositioning themselves to be more competitive. Britain will find it hard to compete on costs.

There is a need to think globally to seize the opportunities as economies in Asia, Africa and the Middle East grow. The UK Treasury has highlighted the need for us to become flexible, innovative and entrepreneurial. This means low taxation, light regulation and improving skills. Let’s hope the success seen in our monetary policy can be translated to other policy areas in the years ahead. Then we really would have something to celebrate.

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