Clarke should have raised base rates

It was no surprise that the Chancellor took advantage of the excuse of the strong pound and some slightly weaker-than-expected figures to avoid raising base rates this month. He has made a mistake, nevertheless.

This is an increasingly lonely position to take, for many experts in the City join Mr Clarke in not taking the 2.5 per cent inflation target that seriously. This school of thought is happy enough to point to short- term trends that will take inflation lower this year, but they do so only by ignoring longer-term pressures that will take it higher again next year. And by the time next year rolls around it is a safe bet that the same commentators will not be very troubled by inflation of 3 or 4 per cent if squeezing it lower requires slower growth.

There is still a large segment of opinion in the UK that believes low inflation is actually not the right policy target. It is an unspoken assumption that there should be a target for growth instead, subject to a maximum permissible degree of inflation. This is the only explanation for the quite widespread City support Mr Clarke receives for his all-too- relaxed stance. His supporters argue that the inflation environment is benign, and the UK economy is only growing a bit above its trend rate at the moment.

If it seems unduly hawkish to disagree with this, in the light of figures showing that the target measure of inflation did actually edge a little lower last month, consider that UK inflation is twice the rate of that in the core Continental countries, well above the European average and about the same as in the very buoyant, fully employed US economy. Britain has actually not had to do very much to transform itself from a high-inflation to a low-inflation country. We have simply taken advantage of favourable world-wide trends in prices.

It is this stubborn psychology that is more likely than anything else to keep Britain out of the European single currency, regardless of what Parliament wants to do. Not only is there a good chance that the UK will not satisfy the Maastricht criterion for inflation, but most of us do not seem to care much about it either.

Mr Clarke is ultimately a politician, not a saint. He is also one who still harbours hopes of winning the election. Let us not forget, however, that he invented the expression that good economics is good politics. A quarter-point rise in base rates yesterday would have signalled his determination to hit his own inflation target, not just for a few months this year, but in the long term too.

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