It is a sad reflection on the low opinion markets have of politicians that market confidence rises when politicians give up one of the main levers of economic influence, and it is surprising that the first thing a Labour Chancellor does after waiting 18 years for power is to give it up.
That is not quite true of course. The Chancellor did abdicate direct control of interest rates between 1972 and 1978 when we had a minimum lending rate which was set by a formula based on market rates. But it proved too passive an economic lever and in 1978 the Chancellor took back the power to dictate rates. He may well have to do so again at some future date.
Meanwhile the Chancellor still has the right to appoint the members of the committee which will set the new rate, and he also sets the inflation rate target the committee is supposed to maintain. From that point of view they are a useful lightning conductor. If they fail to maintain it they have not been tough enough, but if they achieve overkill they will quite rightly make themselves very unpopular.
Only a few died-in-the-wool monetarists still think that zero inflation is a desirable end in itself, when the empirical evidence of the last 50 years suggests that economies do best when prices are rising only slowly, but still fast enough to encourage investors to take some imaginative risks in looking for a positive return.
But there is no doubt the Chancellor has achieved more with a token quarter- point rise in interest rates to point the committee on its way than he could have done with a bigger rise in interest rates alone. Interest rates would have been moving up anyway, and anything which achieves the effect of rising interest rates without the pain has to be a good thing for the economy as a whole and borrowers in particular.
Although the committee is supposed to be oblivious to the pain which any increases in interest rates it orders will cause, the chances are that interest rates will now be lower than they would otherwise have been - at least for the next 12 months.
Building societies and banks are still not wholly convinced that the Chancellor's final signal to the money markets will be enough however. At 7.6 per cent the Halifax is halfway anticipating another quarter-point rise in base rates, and the Nationwide is also waiting for a further sign. But the chances are that while the honeymoon lasts and if the Chancellor produces a good budget in July that base rates will not now reach 7 per cent this year - good news for both the economy and borrowers.
Not everything went in the right direction this week. The pound initially moved sharply higher and only started to weaken on Thursday following rumours that for his next trick the Chancellor was planning to put the pound back into the European Exchange Rate Mechanism at 2.50 marks, some 30 pfennigs less than its current level.
This seems inherently implausible, bearing in mind the political implications of pegging the pound to the mark again prior to a decision on the single currency and the referendum which must precede implementation.
As the rumours die down the pound is likely to strengthen again, which is just what the Chancellor does not want it to do. A strong pound reduces the cost of imported goods and raw materials and helps to reduce future inflation, but at the cost of reducing demand for exports, slowing the growth of the economy and creating more unemployment, which is the last thing the Chancellor wants as he sets out to create 250,000 more jobs for young people currently out of work.
But a strong pound is what we are now likely to get, especially if the new committee at the Bank of England behaves predictably and starts edging base rates up a quarter point every three months.Reuse content