Stark warning that the Bank is not 'on the case'

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The Independent Online

A senior Bank of England policymaker has issued his most outspoken warning yet that the Bank is not "on the case", and that a "sharp" rise in interest rates may eventually be needed if they are not increased soon. Andrew Sentance, an external member of the Bank's Monetary Policy Committee, argues that "the UK economy should be able to withstand a gradual rise in interest rates, even taking into account the impact of fiscal consolidation."

Mr Sentance said: "Raising Bank rate sooner rather than later would provide more protection against upside risks." He added that it would also "help build confidence that the Bank of England is 'on the case' in terms of its remit".

Mr Sentance argued further: "The longer we keep interest rates at an exceptionally low level, the greater is the risk that Bank rate would need to rise sharply in the future – creating a serious setback to business and consumer confidence. We should seek to avoid such a sudden lurch in policy."

Mr Sentance has voted for a modest rise in rates and against further "quantitative easing" – the direct injection of money into the economy – in each of the past six months. On the other end of the MPC spectrum, Adam Posen, another external member, has voted and argued for an extension of QE. The majority view on the MPC for a year has been for no change, reflecting how finely balanced the risks are judged to be.

As the Office for National Statistics confirmed that growth in the third quarter of the year stood at a relatively healthy 0.8 per cent, Mr Sentance challenged the widespread orthodoxy in the Bank that there is such a wide margin of spare capacity in the economy that the dangers from future inflation are minimal.

Mr Sentance believes that the Bank's economists may be misreading the signals. "Spare capacity has not exerted as much downside pressure on cost and price increases as expected. That is partly because the margin of spare capacity appears to be less than we have seen in previous economic cycles," he said. He suggests that spare capacity in the service sector in particular does not appear to be holding down inflation.

The ONS data suggests that exports are helping to boost the economy, but that business investment is a source of weakness.

The debate about the underlying strength of the economy will gather pace on Monday when the Office for Budget Responsibility publishes its latest forecasts, and the Chancellor, George Osborne, makes his Autumn Statement. The OBR will have to revise its forecast for 2010 upwards, as the 1.2 per cent previously estimated has already been exceeded; the numbers for 2011 could conceivably be trimmed. Government borrowing figures for this year may be better than expectations. Business surveys have pointed to a slowdown in recent weeks.

Wirtschaftswunder 2?

For now, at least, the German economy is sailing serenely past the traumas in the rest of the eurozone and, seemingly, powering its way to a second "Wirtschaftswunder", the export-led economic miracle of the 1950s. In November the key Ifo index of business sentiment rose to its highest level since German re-unification 20 years ago: consumer confidence is at its highest since before the credit crunch.

The evidence is that Germany is returning to its traditional position as Europe's engine of growth, having lost some of its competitive edge in the 1990s and 2000s. Third-quarter GDP growth was 0.7 per cent, marginally slower than Britain, but likely to be more sustainable and broadly based. Exports, especially of capital goods to China, are strong and the German consumer is returning to the shops, at last.