Bank warns of need for tight Budget

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The Independent Online
The Bank of England warned yesterday, in its first inflation report since gaining independence, of the need for tighter policy to keep inflation on target in the longer term. The report was widely seen in the City as a warning that the newly liberated Bank would raise interest rates again during the next few months unless the Chancellor increased taxes in the Budget.

"They have given Gordon Brown a breathing space, but the message is fairly explicit. If he fails to deliver in the Budget, they will push up interest rates," said Jonathan Loynes at HSBC Markets.

David Bloom at James Capel agreed. "It is all in central bank language, but the signal could not have been more blatant," he said.

And Richard Iley at Hoare Govett said: "The Bank is clearly giving the Chancellor the chance to limit the scope of rate rises by producing a tight Budget."

Share prices set a new record yesterday, with the FTSE 100 index up more than 21 points at 4,691. But the Bank's message got the blame for knocking it below the 4,700 level it had breached earlier in the day.

The inflation report predicted that underlying inflation will fall below the 2.5 per cent target this year but would be approaching 3 per cent by the end of 1998. It admitted that the contrast between buoyant domestic demand and the likely impact on exports of the strong pound meant the recovery had become unbalanced.

It concluded that there was a policy dilemma: "Higher interest rates would dampen domestic demand, but if they led to a further appreciation of sterling, would worsen the imbalance."

Last week Eddie George, the Bank's Governor, said during a briefing about its new freedom to set interest rates: "Other things equal, if you tighten fiscal policy you would expect that to lead to lower monetary growth and lower inflation."

Mervyn King, the Bank's chief economist, would not comment directly on the Budget yesterday, saying there was no simple trade-off between fiscal and monetary policy. But he said the imbalance between different sectors of the economy was a matter for concern.

He said the short-term outlook for inflation was very favourable, as it should be with such a strong exchange rate. But he added that, despite last week's quarter-point rise in interest rates, it was still more likely than not that inflation would be above target two years hence.

Gordon Brown is due to restate the inflation target in next month's Mansion House speech. It will be at least as tough as the current "2.5 per cent or less", the Chancellor has pledged, but there is speculation that the target could take the form of a range instead.

The new Monetary Policy Committee, which will be the forum within the Bank for interest rate decisions, would decide when and how much rates should move month by month, Mr King said yesterday.

The inflation report listed strong consumer demand, the acceleration in monetary growth, cost pressures in services and the tighter labour market as reasons for concern about the longer-term inflation outlook.

Figures due today are expected to show another big monthly drop in the number of people claiming unemployment benefit.

The TUC yesterday urged the Government to introduce a new measure of unemployment to replace the monthly claimant count of the number of unemployment benefit claimants. It called instead for a monthly survey measuring all those looking for work in the previous four weeks, regardless of whether they qualify for benefit.

Regardless of such doubts about the statistics, most economists accept that unemployment is falling rapidly.

However, today's figures are not expected to show a further pick-up in earnings growth, while retail price figures tomorrow are likely to show a small decline in the underlying rate. Simon Briscoe at Nikko Europe said: "The inflation situation is not serious." He suggested the Bank could afford to take a relaxed attitude for now.

The Treasury said yesterday that it would consult gilts market participants about the planned switch of responsibility for the sale of gilts and management of government debt from the Bank to the Treasury. The move would be implemented as early as feasible after the end of July.

Geoffrey Robinson, the Paymaster General, said utilities would have to submit their representations about the planned windfall tax by the end of this month.

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