At last, independence for the Bank

Chancellor's move heralds cheaper long-term money
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The Independent Online
Diane Coyle

and Nic Cicutti

Gordon Brown's snap decision to grant the Bank of England its immediate independence was greeted with amazement and delight by the financial markets yesterday.

The expected rise of a quarter point in base rates, to 6.25 per cent, added to the general City satisfaction. But homeowners will face higher mortgage costs as several big lenders increased their rates in reaction, raising the monthly cost of a home loan by about pounds 13 for a typical pounds 50,000 mortgage.

Share prices leapt to a new record, and the interest premium on British government debt fell by almost half a percentage point.

The Chancellor said the previous arrangements of monthly meetings between his predecessor and the Governor of the Bank of England had not generated enough confidence. "The perception that monetary policy decisions have been dominated by short-term political considerations has grown," he said.

He said the Bank would have the operational independence to set interest rates in order to achieve the inflation target. "I want British economic success to be built on the solid rock of prudent and consistent economic management, not the shifting sands of boom and bust," he said.

The FTSE 100 index climbed above 4,500 for the first time, ending nearly 64 points higher at 4,519.3. Gilts soared to their highest level for three years as the premium over German bunds declined sharply. In a less welcome response, the pound also moved higher, with the sterling index rising nearly a point to 100.6.

Most experts, in the City and outside, welcomed the Chancellor's decision. Economists said base rates might rise by more than they otherwise would in the short term, but long-term borrowing costs would be lower.

James Barty, an economist at Deutsche Morgan Grenfell, said: "It's a stroke of genius. It has caught all of us in the markets on the hop."

Michael Hughes, head of research at BZW, said: "The Government has taken an important and long overdue step towards achieving the end of stabilising the economy."

David Currie, a professor at the London Business School and Labour peer, agreed: "This is a very important break with the past."

Eddie George, Governor of the Bank of England, was, not surprisingly, delighted. "We will not be distracted by political considerations. We are doing a technical job," he said.

Mr George, who revealed that he had learnt about the plan on Monday morning, said he would not have sought more independence than the Chancellor had offered, as the setting of the policy targets was rightly a political matter.

The Bank's new independence takes effect immediately. The Government will continue to set the inflation target, which it has said will be at least as tough as the current 2.5 per cent objective. But a new monetary policy committee at the Bank will set interest rates to achieve the target by majority vote. The committee will consist of the Governor, his deputy, a new second deputy, two Bank executive directors, and four monetary experts appointed from outside the Bank.

These four will be Bank officials, although not necessarily full time. They will, however, have to give up all outside commercial interests.

The main concern City economists had about Mr Brown's move was whether these new appointments would be subject to political pressures. Simon Briscoe at Nikko Europe, said: "You could just get a range of Labour Party supporters making the judgement. That's not independence in any meaningful way."

The committee, whose membership will be announced as soon as possible, will be accountable to the Treasury Select Committee of the House of Commons. Gavyn Davies, chief economist at Goldman Sachs and considered a front- runner for the new deputy governorship, said: "This is an incentive for the Treasury committee to get better. This will be the prime form of political accountability."

The Chancellor's decision to raise interest rates on the Bank's advice yesterday, overshadowed by the more dramatic move, gained a more mixed reaction.

Mr Brown admitted that the strength of sterling meant there was a policy dilemma, and said the Government wanted a stable and competitive pound over the medium term.

Two surveys yesterday highlighted the dilemma. The monthly services indicator from the Chartered Institute of Purchasing and Supply showed further strong growth in the sector leading to higher wage costs. But a CBI industrial survey showed that manufacturers in all but one region had had to cut their prices because the exchange rate was hitting export orders.

The increase in base rates will also hit home owners.

Mortgage lenders reacted within hours by increasing their rates by an average of 0.35 per cent to about 7.6 per cent.

The move was justified by lenders as being almost inevitable after months of deliberately keeping rates down.

Andrew Pople, managing director of the retail division at Abbey National, whose tiered rates rose by a similar amount, said: "An increase in base rates had been expected for some months ... and the proposed independence for the Bank may mean that further base rate changes are possible in 1997."

But Mr Pople added that he did not foresee mortgage interest rare rises on the scale of the early 1990s during the present Labour administration.

The Halifax, which also raised the cost of its mortgages by 0.35 per cent, stressed the rates increase would be welcomed by millions of savers, who outnumberered borrowers seven to one.

Mike Blackburn, chief executive at the Halifax, said: "We do not believe this increase will halt the recovery. Mortgage rates are still at a relatively low level."

Coventry Building Society also joined other lenders in raising its rates. Northern Rock stressed that the 6.09 per cent variable rates from its newly launched telephone arm would remain unchanged for the moment.

Mr Brown said: "We are setting out a framework to end the boom and bust instability of recent years."

Comment, page 21

Main reforms

BoE given responsibility for setting interest rates

Government can resume control of interest rates 'in national interest'

Monthly meetings between Chancellor and Governor to be abolished

Creation of post of second deputy governor of Bank

New Monetary Policy Committee created

Court of Bank reconstituted

BoE's role as Government agent for sale of gilts transferred to Treasury