So far, the Bank Governor's demand for a rise in interest rates to counter incipient inflation regardless of the impact on the economy and the electorate - while the Chancellor blandly ignores the promises he made only last year to listen to the Governor's opinions - has signally failed to upset the markets.
Shares, sterling and government securities have all held up well to the latest warnings in the Bank of England's Inflation Report.
But this is largely due to the fact that UK investors want to believe the Chancellor is right. Influential market analysts believe that interest rates in most other advanced economies are likely to go down and help take the pressure off the pound if the Chancellor refuses to do what the Governor tells him markets require. Finally, and perhaps fortuitously, the OECD has given the UK economy a clean bill of health in the past week.
Any decision to raise rates is unlikely to be taken until after the Chancellor and Governor next meet, which is not until the very end of this month. For the time being, there is every chance that the Chancellor can and will, rightly in my opinion, ignore the carping of a man whose job is to see only one side of the inflation and interest rates/ economic growth and interest rates coin.
The most we are arguing about is a few tenths of a per cent of inflation over target, and it would be ridiculous of the Chancellor to wreck a recovery which is already slowing for such a pedantic and small-minded objective.
It was fairly ridiculous of him to give the Governor the opportunity to upset the apple-cart in the first place, but that is another story. Let us give the Chancellor credit where credit is due.
But the markets are unlikely to be so forgiving if Mr Clarke holds down interest rates and then tries to cut taxes in the Budget, which is now less than four months away. He is under intense pressure to do so from Tory backbenchers desperate to stop their seats going the way of Littleborough and Saddleworth, and also from the hard right, which sees tax cuts as the best way of forcing the Chancellor to rebalance the books by slashing away still further at Government spending.
But further spending cuts will not be that easy to find, as John Redwood discovered when pressed to say how he would achieve savings as Prime Minister. Economic growth is unlikely to provide a painless answer either. The economy has already slowed down, and the flow of tax revenues has been reduced to the point where the public sector borrowing requirement is running well above the level needed to meet the Chancellor's own target of cutting it by a quarter, to pounds 26bn, in the current financial year.
He can tinker with taxation, and it would be electorally rewarding to try and revive the housing market with judicious concessions. But he cannot expect to cut the overall level of taxation in November without the market noticing that an unsustainable pre-election boom is being engineered.
If tax cuts are not paid for by cutting spending programmes, they will have to be paid for by raising interest rates, and even that might not be enough to placate those unforgiving markets. Even if tax cuts and interest rate rises were a fair and equitable trade-off, which they are not, it would be an unacceptable risk to take.
The Chancellor certainly cannot expect to cut both interest rates and taxes this autumn. Given a choice between them, he should give priority to interest rates.Reuse content