Economics: An opening for the Governor

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The Independent Online
IT WOULD be churlish not to welcome Kenneth Clarke's decision last week to publish the minutes of the monthly meetings at which he discusses interest rates with the Governor of the Bank of England. But whether this improves the quality of the decisions Mr Clarke takes at these meetings remains to be seen.

Nevertheless, occasions when the Treasury's espousal of 'openness' amount to more than diversionary platitudes are few and far between, so a real advance such as this should not be dismissed. The Treasury has now gone as far as the US Federal Reserve in shedding light on the making of monetary policy - and a good deal further than the Bundesbank.

In a country as secretive as Britain, the regular publication of discussions between a minister and his advisers is almost unprecedented and a testament to Mr Clarke's apparently boundless self-confidence. We can only hope that it will have knock-on effects in other areas of government activity.

The exercise is intended to give the City and the public a guide to the thinking that underlies interest-rate decisions, in the hope that this will prevent damaging speculation about policymakers' motives and future intentions.

But this can only succeed up to a point. The markets cannot afford to wait until the minutes are published six weeks after the meeting has taken place (and two weeks after the meeting that followed it) to make up their mind about the wisdom of each decision. Experience shows that the markets are pretty good at sniffing out disagreements and reluctant compromises without official assistance.

More fundamentally, the value of the minutes depends on their being a reliable and unbowdlerised account of the discussions between the Chancellor, the Governor and their officials. Cynics will no doubt point out that the minutes could be fiddled. Mr George has already admitted that references to possible changes in tax, public spending and exchange rate policy - all of which have a crucial bearing on interest rate decisions - will be excised because of their market sensitivity. So it will still be necessary to read between the lines.

But the gory detail in which the minutes released last week described the disagreement between the Chancellor and Governor over the need for the February's cut in base rates does suggest that the blue pencil will be used with a light touch. The Governor has even started to take his own notes of what is said in the meetings, just in case he wishes to dispute the Treasury's account.

This in turn means that it will be more difficult for the Chancellor to get away with interest-rate cuts - or to dodge increases in rates when a rise in inflationary pressure warrants them - for blatantly political ends.

The most obvious recent example was the reduction from 7 to 6 per cent forced on Norman Lamont by the Prime Minister in January last year after he was spooked by some bad unemployment figures.

We must hope that the Governor will voice his opposition to such shenanigans and then ensure that his objections appear in print. Mr Clarke will no doubt bear this prospect in mind and not wish to push his luck.

But Mr Clarke has always admitted to being a 'political' Chancellor first and foremost. This still shines through in the accounts of the first three meetings of the year, all of which took place in the knowledge that their minutes might be published. Mr Clarke's initiative in no way signals his transformation into a disinterested economic technocrat - he remains at heart a politician with an eye for the main chance.

This may give the markets some cause for concern in coming months, and the Chancellor may well come to regret that his reputation, as a politician first and an economist second, is regularly subject to such detailed and public confirmation. The drop in the pound and gilt prices following the publication of the minutes last week may only be a foretaste of the nervousness to come.

The minutes clearly demonstrate that Mr Clarke has long been more concerned in private that his tax increases will slow the recovery than he has so far admitted in public. This concern is no doubt as much political as economic, as voting intentions are strongly influenced by the state of the economy and voters' sense of their own financial well being.

Mr Clarke felt that cutting base rates by just half a point in the run up to the Budget 'erred on the side of caution' and that the case for another cut in rates in January was 'quite strong'.

He then argued that the case for lower rates had improved between January and February, even after the Governor warned that, to his mind, the evidence on the economy and inflation 'weakened rather than strengthened the case for an immediate interest rate cut'.

The Governor argued that the case for an immediate rate cut rested on evidence that the Budget had slowed the recovery, but that no such evidence had yet appeared. He warned that any rate cut in February 'would run a risk of higher inflation and some loss of credibility', but the Chancellor disagreed and pushed for a half- point reduction.

The compromise on a quarter-point rate cut that emerged from the February meeting demonstrated that Mr Clarke is quite willing to cut rates, even when the Governor 'strongly advised against'. The publication of the minutes may give the Bank more clout in policymaking, but there is no sign yet that Mr Clarke intends to hand control over interest rates entirely to the Bank by granting it the formal independence recommended by the Treasury Select Committee.

The fact that five out of the last six quarterly inflation forecasts by the Bank had proved overly pessimistic may have emboldened the Chancellor. But if Mr Clarke imposes his will in this fashion too often, the markets will almost certainly become alarmed.

The Chancellor claimed as he launched the openness initiative last week that it was 'plain as a pikestaff' that he had been right to cut rates in February. But during Mr Clarke's brief absence to vote in the Commons, the Governor muttered that it was arguable whether he had 'lost the argument, or just the decision'.

There is something to be said for each view. The Chancellor will take comfort in Friday's announcement that underlying inflation dropped from 2.8 per cent in February to 2.4 per cent in March, which shows that the Bank is still being excessively pessimistic in its short-term forecasts.

Inflation in the service sector fell particularly sharply, offsetting rises in clothing and footwear prices.

The Chancellor concluded in the minutes for the meeting in early March that there was still a case to cut base rates further if recovery slowed and inflation remained subdued. The evidence on recovery is still not decisive, but Friday's inflation figures are unlikely to have shaken his view that the next move in rates is more likely to be down than up. But the Governor is rightly more concerned about where inflation is going in two years' time and is determined that the markets should come to be confident that low inflation will be maintained. As the graphic shows, expectations of long-term inflation have been deteriorating steadily in the gilts market since January.

The markets still suspect that inflation will settle down above the ceiling of the Chancellor's 1 to 4 per cent target range, despite his stated desire to have inflation in the lower half of that range by the end of the Parliament. Friday's surprisingly good inflation figure has done little to reverse that view.

This is not the sort of environment in which the Chancellor should cut rates again, except in the unlikely event that the tax increases clearly threaten to stop the recovery in its tracks. If future minutes show the Governor successfully dissuading Mr Clarke from another cut and - more importantly - persuading him to raise rates when inflationary pressures mount, then Mr Clarke's initiative will have proved its worth.

Robert Chote was last week named Young Financial Journalist of the Year in the annual Wincott Awards. The judges cited the maturity, judgement and technical competence of his writing.

(Graphs omitted)

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