View from City Road: Rate rise was a sensible precaution

No sooner does Kenneth Clarke bite the anti-inflation bullet and raise interest rates than the underlying rate of inflation falls to a fresh 27-year low and even more safely within his target range. This is not the magic trick it seems, however. Rises in base rates take a year or two to put significant downward pressure on inflation and the two events are not linked.

As usual, the movement in inflation was in part explained by special factors. The summer sales have been more concentrated this year than last and August's erratic rises in petrol and potato prices have been partially reversed. Even so, inflationary pressures across the economy as a whole remain subdued. Retailers still find it difficult to make their customers swallow price rises.

This may seem odd given that the economy is growing at almost 4 per cent a year. Growth is significantly stronger than its 2-2.5 per cent long-term trend rate. In the long term, growth above the trend rate is always likely to fuel price increases. But in the short term, rapid growth is paradoxically a tonic against inflation.

If the economy is managing to produce more goods and services without employing more people, then companies will be spending less on wages and salaries to produce each unit of output. By keeping costs down, this relieves the pressure on firms to raise their prices and takes the sting out of higher fuel and raw materials costs.

Which way is employment moving? It can be measured in two ways - asking companies how many people work for them and asking individuals if they have a job. The first measure shows that job-shedding is continuing. With rapid output growth, the implication is that the lid is being kept on labour costs.

Surveys of individuals give a different picture. They suggest jobs are being created once more, which would imply that the downward pressure on labour costs is not as strong as it might appear.

The Department of Employment is to investigate the discrepancy between the two employment figures. Labour costs are almost certainly more of a problem than the official figures suggest. That possibility alone means Mr Clarke's rate increase was a sensible precaution.