View from City Road: Bank takes bath in high-noon fiasco

If the Bank of England wants us to believe that it can be trusted with custody of British interest rate policy, then yesterday's fiasco in the money markets has surely profoundly damaged its case. To sit back calmly while September interest rate expectations climb by almost half a point in the course of a single lunchtime suggests that the Bank cannot be trusted to run a bath, let alone one of the key levers of economic management.

An exaggerated comment, perhaps, but yesterday's events justify strong language. Chaos reigned in the markets after the Bank accepted tenders for Treasury bills at an interest rate three-quarters-of-a-percentage point above that at which it accepted tenders a week ago - as always, a decision ratified personally by the Governor, Eddie George. Such largesse is uncommon, to put it mildly; the market promptly concluded that such a dramatic increase was a clear signal that Mr George and Kenneth Clarke, the Chancellor, had agreed to raise interest rates at their meeting last Thursday, and that the Bank was teeing up a rise for early next week.

Whether this is the right interpretation is anyone's guess. It could well be that the Bank has merely changed its policy and is now prepared to flog off Treasury bills at whatever the market demands. If so, the markets might have been given a little more forewarning. As far as they were concerned, this was as clear a signal as they come. Conflicting messages from the Bank and the Treasury failing to clear the air because several key officials in its monetary policy division were away on holiday, only added to the confusion.

All this took place against the worst possible background: a market already nervous about pre-emptive interest rate increases because of Thursday's meeting between the Chancellor and the Governor. The nervousness had been exacerbated by the looming prospect of next Tuesday's inflation report from the Bank, and by a leaked survey from the Chartered Institute of Purchasing and Supply pointing to sharply rising inflation pressures. About the only thing that went right yesterday was the unexpectedly subdued figure for US second-quarter growth, which at least calmed fears of an imminent rate rise in the US.

Many dealers in the gilts and futures market, nevertheless, left work yesterday evening believing that even if the Bank and the Treasury had no intention of raising interest rates on Thursday, then they might be forced into it by early next week. Unless this is some Machiavellian ruse by the Bank to force an interest rate rise on the Chancellor, it is hard to see why the Bank should have poured fuel on the flames in the way it handled the Treasury bill tender.

If only it had pulled the issue, it might have ended the week with some credibility intact. As it is, the Bank, after a good year, has considerably damaged its case for full independence.