Comment: A different note from the Bank

A different note from the Bank

The Bank of England sounds a very different note in its latest Inflation Report from the warnings in the previous two documents. Three months ago, the Bank said that delay in taking action could ultimately result in interest rates having to go higher than would otherwise be the case. Now, with interest rates on hold at their present level at 6.75 per cent for the best part of a year, the Bank counsels a "wait and see" approach.

This is hardly surprising, given the fact that its central projection of underlying inflation in two years' time is now only fractionally above the Government's objective of 2.5 per cent or less. The Bank also says that the chances of meeting that target have improved and that it is more likely that inflation could come in below 2.5 per cent. All this, however, is predicated on the assumption of unchanged fiscal policy - and there's the rub.

For the political smoke signals suggest that Kenneth Clarke will spring more of a surprise in his Budget in the way of tax cuts than is commonly recognised. While the Chancellor will no doubt pledge compensating spending cuts, past experience suggests that it will be difficult to sustain them in the run-up to an election. In which case, the Bank should be preparing to cry foul and demand an offsetting tightening in monetary policy.

Yet in reality, the debate in their monthly monetary meetings is much more likely in the not too distant future to centre on demands from the Chancellor for a further cut in interest rates. With manufacturing declining in September and a flat housing market, he has an increasingly strong hand to play. As the Bank conceded, the risk of a setback to output through destocking has increased since the last report in August.

The Bank is at pains to emphasise that in previous recoveries output has declined in at least one quarter. Indeed, it points out how "remarkably smooth" the pattern of output growth has been in the present upswing. But if an inventory correction does bring about a temporary fall in GDP, the Bank will find it difficult to resist pressure from the Chancellor for a cut in interest rates.