Put up base rates now, it was argued, to steady the markets through the holiday period by demonstrating that the authorities were prepared to act early in the face of rising inflation.
The trouble with this is that there is really no evidence yet of rising inflation. What we have, from the CBI survey earlier this week, is evidence that industry would like to raise prices. Whether it will be able to do so to any extent in the coming months will be an important indicator of the scale of the next cyclical rise in inflation and hence interest rates; and, more importantly, whether there has been a sea change in the inflation outlook beyond the next cycle.
The majority opinion in the bond markets is that, whatever happens to British inflation during the next cycle, the 15- to 20- year outlook is for it to average between 3 and 5 per cent. Present bond yields assume inflation at about 4 per cent, and the commentators at the more bearish end of the scale are talking about inflation during the coming cycle peaking at perhaps 6 per cent, before falling back. We would be heading into Fifties and early Sixties territory, but not to the stability of the past century.
There is an alternative view that had its moment of high fashion about the turn of the year but now finds few supporters. This is that the long-run downward trend of inflation in the developed world that started in the early 1980s is intact. The consequences of this are not only that inflation here during the next cycle is unlikely to peak at much more than 4 per cent, but the longer-term outlook is for inflation to be perhaps in the minus 1 to plus 2 per cent range.
Whether this happens is a global matter: we may do a little better or worse than other developed countries, but the world trend is more important than our relative performance. This is not the place to go into the reasons for holding such a view, except to observe that the fact that the bond markets are so sceptical paradoxically increases the chances of zero inflation coming about.
One of these two views is clearly completely wrong. What we need are test cases, and the ability of industry to sustain price rises as output increases will be one. That is not happening. Market pressure is still squeezing prices in whole swathes of the economy: supermarkets, electrical goods, the motor trade, newspapers.
Manufacturers have been able to hold down prices because productivity is still rising faster than wages: manufacturing productivity is up at an annual rate of 5.8 per cent in the past three months. With pay settlements at about 2.5 per and actual earnings rising at one percentage point more, this means that unit labour costs are still falling, enabling industry to hold prices in the face of rising raw materal costs.
For the moment, then, it is perfectly possible to argue that the low-inflation outlook, however unfashionable it has become, may still be the right one. Add to this the other evidence that inflationary pressures are still muted and it is really quite difficult to see how the case for the base rate rise could be sustained.
This will change in the autumn. Go down the list of the items we know the Bank of England looks at when making judgements about base rates and one can see that there will soon be a case for a half- point rise.
First, money supply growth (M0) will still be running way above the top of the target range. Next, commodity prices will presumably have remained strong. Those two alone would warrant some rise. If earnings growth, while still under control, had also nudged up a little, and asset prices (particularly houses) were showing any buoyancy, the case would become much stronger. If sterling were to weaken (not particularly likely but always possible) the case for a sharp rise would become irresistible.
Finally, there is the question of tactics. Since the mismanagement of the last 25-point cut in base rates, a compromise between the Bank and the Treasury that the markets immediately rumbled, the authorities have felt themselves on trial. The next move in rates needs to be seen as sensible and ordered. A pre-emptive move might well be misinterpreted as showing more concern about inflation than was justified, while acting too late would be worse.
Anyone wanting to guess the timing of the move should, perhaps, watch money market rates. The three-month rate has nudged up a little in recent weeks, from about 5.1 to 5.3 per cent. Were it to move to, say, 5.7 per cent, a rise in base rates could be justified as validating market moves. Not a bad policy, from both a political and a practical point of view.Reuse content