Business Comment: Flash Gordon should not have moved the target

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The Independent Online
Flash Gordon seems to be losing some of his superhuman powers. The pace of activity continues unabated, but the Chancellor's latest initiative has left them less than wowed in the aisles. To say that the City reacted badly to Mr Brown's Mansion House speech would be overstating it, but, unlike his whirlwind of activity to date, the new inflation regime was greeted with as little enthusiasm as his lounge suit among all the dicky bows and dress wear of the Lord Mayor's dinner last night. Indeed Mr Brown's remarks were widely seen as a watering down of the previous Government's inflation target.

Is this a fair assessment of the new inflation objective and even if it is, does it really matter? The answer to the first question is clearly yes, the answer to the second, rather more debatable.

To set an inflation target of 2.5 per cent but only call the newly independent Bank of England to account if it exceeds 3.5 per cent obviously demands a less onerous monetary policy than if the target is strictly 2.5 per cent or less. The old regime would have required the Bank to err more on the side of caution than does the new one. Indeed the new one gives the Bank a positive incentive to be less than cautious since it will also be called to account should policy cause inflation to fall below 1.5 per cent.

Aiming for 2.5 per cent but able to range up to 3.5 per cent is not quite as tough as keeping inflation at 2.5 per cent or below. The reaction was not over-dramatic, but short sterling prices indicated the markets now expect one fewer rise in interest rates during the next 12 months.

Thankfully, the City isn't yet the only judge of these things, and in fact Mr Brown can claim some justification for the change. One of the things he wants to do is reassure critics that his move to give the Bank of England operational independence will not allow the inflation hawks in Threadneedle Street to keep the economy permanently depressed in pursuit of ever-lower inflation.

The Treasury's spin doctors claimed yesterday that inflation will actually turn out lower under the new regime because the Bank is now free to act of its own accord, even though its remit appears a little looser. Plainly there's something in this. The old target might have been tougher but Ken Clarke didn't really want to hit it and allowed policy to drift accordingly.

In practice, the Bank is in any case unlikely to sit idly by if target inflation does reach 3 per cent and is still climbing. Although the new inflation target is symmetric, the Bank's own preferences are not. It will lean towards the lower figure.

Even so, it is hard to imagine the Bank finding it as easy to increase interest rates again this year as it would have under the old regime. Its current forecast shows inflation at about 3 per cent in early 1999. With growth still romping away, a "2.5 per cent or less" target for inflation would require at least one base rate increase and more likely two. Even a Chancellor as relaxed as Mr Clarke would have had to bow to the inevitable. But imagine the fuss from the Bank's critics if it goes ahead now when its own forecast shows no sign of reaching the new upper limit for the next two years.

Mr Brown's new target is a bit of a disappointment. He has tried to find a clever compromise that will satisfy both those who welcome Bank of England independence and a tough inflation regime, and the lobby that reckons the Bank is over-hawkish and ignores the needs of industry and employment.

But the Chancellor should have left the newly independent Bank with the old inflation target, and trusted Eddie George and his committee not to overdo its zealousness. After all, a majority on the committee will soon be Brown appointees.

To establish credibility as a low-inflation economy, Britain does need a prolonged stretch at 2.5 per cent or less. Whatever the good theoretical grounds for setting the Bank a target that prevents it doing too much on interest rates as well as doing too little, it could have waited. Since he plainly has not delivered on his promise to be "at least as tough" as his predecessor on the actual inflation target, the Chancellor has been in too much of a rush to change it.

No wonder long bond yields are still so much higher than those of Germany, despite the well-justified dive they took when Mr Brown announced the Bank's new operational independence. No one quite believes in the British economic miracle yet. Mr Brown has given the sceptics an excuse for saying: "Told you so."