View from City Road: It is time for the Chancellor to act

Having stirred up a frenzy of speculation about an imminent rise in interest rates last Friday, the Bank of England yesterday sat on its hands and left the markets waiting on tenterhooks for today's quarterly Inflation Report.

The report will have to be remarkably sanguine about the prospects for inflation if the markets' nervousness is not to endure. The Chancellor of the Exchequer and the Governor of the Bank may have decided last Thursday to leave base rates alone for now, but things may already be out of their hands; the markets seem to be determined to force the pace.

The British authorities have a long- standing history of taking action too late to prevent economic recovery from ending in rampant inflation - the markets would be wise this time to hold them to their word. Eddie George, Governor of the Bank, is as determined not to be seen as trigger- happy with interest rates as he is to be seen taking early and effective action. As far as the markets are concerned at least, the time for caution is long past. The case for a pre-emptive rise in interest rates is becoming increasingly persuasive, especially if Kenneth Clarke is really serious about sticking to his long-term target of 1 to 2.5 per cent underlying inflation.

Official data show that the economy is growing above its long-term trend rate. On past evidence these figures almost certainly understate the pace of recovery. Perhaps most ominously, the economy's spare capacity is being used up with little sign yet of a robust upturn in investment.

A small rise in interest rates now would have little direct impact on the strength of recovery. Certainly the package of tax increases put through in April had no effect whatsoever. By helping to convince the markets that the Government is serious about keeping inflation down, it might even help to boost investment by reducing the rates of return which companies demand to undertake investment projects.

Given the favourable reaction of long gilt yields to Friday's flurry of speculation, it would almost certainly go down better with the markets than the first tightening in US interest rates six months ago. If the Chancellor and the Governor wait too long before raising rates, their chance to look foresighted and decisive will have disappeared.

Kenneth Clarke is on holiday and it cannot have been his intention to have it interrupted by an interest-rate rise. How he must be cursing the Bank for its bizarre actions in the money markets last week, which it now seems were simply misjudged rather than a deliberate signal. Nevertheless, it might be better for him to act now of his own volition rather than be railroaded by already nervous markets.