LAST Thursday’s decision to raise UK interest rates for the first time in ten long years came as absolutely no surprise.

Given the advance thoughts of Governor Carey, the vast majority of commentators expected this increase, albeit only a minority supported the decision.

However, there was a major surprise as the rise was announced, in that the MPC downgraded its expectations for UK growth in the years ahead – essentially thanks to the continuing dire performance on productivity. This will have major repercussions. No wonder sterling tumbled on this news.

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But consider first the rate rise, which is tiny, just one quarter of one percent. The impact on borrowers will be limited, with many/most mortgage holders on fixed rate contracts. Credit card and bank debt will cost somewhat more. This will be distinctly uncomfortable for those households already ‘just coping’ given the impact of higher debt repayments on top of a rising cost of living and falling real wages. But, as the Monetary Policy Committee emphasised, interest rates, at a bare half of one per cent, remain at an historically low level; and savers will benefit.

The MPC also noted that they expect ‘any further rises to happen at a gradual pace and to a limited extent’. Hence now is not the time to panic, at least so far as interest rates in the short or medium term are concerned.

The real cause for concern is productivity and hence prospects for future growth. As emphasised so often in this column, this is where the real problem exists for the UK and Scottish economies.

In the ‘good old days’, before the 2008 financial crisis, we expected the UK economy to grow on a continuing basis at around 2.5 per cent per annum.

Growth in GDP is (essentially) due to a combination of an increase in the working population and some increase in output per man hour – productivity in other words. This growth of 2.5 per cent was seen as ‘trend’, incorporated a productivity expectation of around two per cent and broadly consistent with maintaining inflation at around the two per cent target set for the MPC by the Government. This was the period a previous Governor described as the NICE era – Non Inflationary Consistent Expansion.

But the MPC has twin objectives for the manner in which it operates monetary policy – namely to maintain stable inflation around this two per cent target level and to set policy in a way that helps to sustain growth and employment.

We all know that inflation is somewhat above target and set to remain there for a while. This factor points towards tightening monetary policy – rising interest rates.

However, while employment is remarkably strong and unemployment historically low, output growth is well below the 2.5 per cent per annum level of those bygone days. The latest data show growth at 1.5 per cent, with forecasts of roughly the same ahead. At first blush this slower growth, below past trend, should work in the opposite direction to inflation trends, suggesting rates being held at existing low levels to help stimulate higher growth.

However, the Bank of England, along with the Office for Budget Responsibility (OBR) which produces the forecasts for the Chancellor to use at his Budgets, has of late become far more pessimistic (some would say realistic) about the productivity story. No longer are we to expect productivity growth at around two per cent per annum, as in the pre-crash era, but at close to zero, half a per cent per annum at most.

Consequently the MPC has cut its estimate of trend growth – what it now calls the ‘speed limit’ for our economy – from 2.5 per cent to a mere 1.5 per cent per year. In other words we are already at the speed limit and acceleration should not be permitted.

This reduction in trend growth is the real shock in the announcement from the Bank of England last week. From now on we are to see growth of 1.5 per cent as ‘good news’. Any growth above that level is to be seen as placing the inflation target at risk.

The implications are major. For a start if we continue to see growth at around this 1.5 per cent, then the MPC must be expected to keep on raising rates until inflation, or rather inflation expectations, fall back to the two per cent target.

But this new ‘speed limit’ must be causing the Chancellor palpitations, with the Budget just over two weeks away.

If the Office for Budget Responsibility (OBR) concurs that the economy is to grow more slowly than previously expected, then so will Government income from taxation. A lower than expected rate of increase in tax revenues means less scope for public expenditure unless taxes are hiked or the budget deficit and Government debt are allowed to increase.

This opens up the prospect of a choice between a longer period of ‘austerity’ than previously planned or a marked loosening of fiscal policy – in direct contradiction to the policy move on the monetary side.

One last thought; at a recent David Hume Institute seminar in Edinburgh Professor Christina Romer, previously chair of President Obama’s Council of Economic Advisors, revealed research findings regarding managing economies through financial crises. Essentially she had determined that countries with scope to lower interest rates and low debt to GDP ratios cope better following crises, because they have the ability to cut rates and increase their fiscal deficit. In the UK nine years after the 2008 crisis there is effectively no scope to face up to a future crisis by loosening on either the monetary or fiscal front – unless the MPC raises rates further and faster than expected to open up room to react to the next crisis.

In sum we face whatever Brexit may deliver with a remarkably low trend growth rate and no scope to loosen policy to deal with any emergency. Oh and by the way... winter is coming!

Jeremy Peat is visiting professor of the University of Strathclyde International Public Policy Institute