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Red faces as George urges rate rise

Eddie George, Governor of the Bank of England, told MPs yesterday that he still thought the Chancellor of the Exchequer should raise interest rates. The Governor's increasingly public advice has become a growing source of embarrassment for Kenneth Clarke, who is keen to avoid increasing the cost of borrowing and mortgages ahead of the general election.

Mr George downplayed reports about the clash of views between himself and the Chancellor, saying there was room for disagreement. He also indicated that the strong pound meant the Bank had backtracked from its advice, in December, that a half-point rise in base rates was needed.

But Mr George left no doubt that the Bank is still advising a tougher interest rate policy.

He told MPs that the strong pound had made the need for higher borrowing costs less pressing. It might even mean the Government would get inflation down to its 2.5 per cent target by the end of this Parliament, he said. "But that would be pure chance," the Governor said.

The UK's inflation performance was not very good by international standards. The Bank was predicting only that the Government might hit the inflation target of 2.5 per cent for a short period this year.

"Domestic demand is not accelerating wildly. We are not talking about a boom. But it is growing above trend which means it is not sustainable for long," Mr George said.

Asked if the Bank was stating its case so strongly to prepare the ground for base rates to rise under a new Chancellor if they did not go up before the election, the Governor said: "Whoever is in power will have to address the strength of domestic demand at some point. We would say that the longer it is left, the bigger the move will have to be."

Sooner would be better, he argued. "As a general proposition, the earlier you move, the less you end up having to do."

The Governor gave a cautious welcome to Labour proposals for a wider monetary policy committee, with members drawn from outside the Bank, to advise on interest rate policy.

"The devil of these things is always in the detail. In principle it would be helpful to us," he said. "The idea that we might have outside people has potential pluses and minuses."

He told MPs on the Treasury select committee that the UK's record on inflation was relatively poor. "Our performance is not as good as we like to think it is."

Greater international competition and technological change accounted for much of the decrease in inflation. "I don't pretend that the reduction in inflation you see in this country is due to a sudden improvement in macro-economic management," Mr George said.

He added: "Our inflation performance has been bad relative to the rest of the world. It is still not that good relative to the rest of the world."

The remarks put in context Mr George's insistence that he and Mr Clarke were not that far apart. "We come to a different conclusion. That seems to me to be an entirely reasonable proposition. The only people who don't seem to get excited about it are the Chancellor and me," he said.

The Governor added: "We are talking about really pretty narrow differences."

The Bank's regional agents had reported less concern about the strength of the exchange rate among exporters than might have been expected. Even so, Mr George accepted the need for a rise in base rates had become less urgent.

The Governor took the chance to repeat his caution about European monetary union taking place before the economies had fully converged.

The Governor added that the pound's 20 per cent appreciation against the German mark "illustrates the potential problem of trying to live with a one-size-fits-all monetary policy".

Mr George agreed that the financial markets had increasingly come to see the euro as a weaker currency than they had first thought.