Leading Article: No interest in a cut

Unsustainable tax cuts may not be the only pre-election sweetener the lucky British electorate is about to be offered. If yesterday's Bank of England's inflation report is taken at face value, inflationary dangers appear to be receding. So expect Tory activists to argue that if tax cuts are not enough to win round a sceptical electorate, Ken Clarke could always bring interest rates down, too. They must be resisted. Their desire for a feel-good boom runs contrary to the economic analysis buried deep within the Bank of England's report and, if acted upon, would seriously jeopardise the low-inflationary recovery Britain has so far managed to achieve.

The trouble is that it is not just the politicians who want relief - economic voices for interest rate cuts are growing, too. The majority of the Treasury wise men believe interest rates could be cut a little in the next few months without too much risk for inflation. After all, wages are still growing surprisingly slowly and companies have such large stockpiles that they may temporarily slow down production.

If not explicitly endorsing these views, the Bank of England appears at first view to have dropped its fierce opposition. We have heard no more from Eddie George about interest rate rises since his embarrassing defeat at the Chancellor's hands in June. And in this latest report the Bank has backed off its previous claim that its own inflation forecast was more likely to be an underestimate than an overestimate.

So what is our problem? Business and homeowners would appreciate a cut. Everyone's in favour - let's do it. Er, no actually, says the Bank of England. Bruised by Barings and afraid of the uncharted territory in which Governor and Chancellor consistently disagree, the Bank may appear cautious about coming to too many strong public conclusions. But the balance of its analysis - as well as evidence from elsewhere - reveals that cutting interest rates would be an extremely foolish strategy right now. Like most City analysts, the Bank still believes inflation will be higher than the Government's 2.5 per cent target in two years' time.

But it is its analysis of the labour market which makes most sober reading. The Bank is worried that wages will start to spiral upwards, and points out several reasons why the current slow growth in earnings may not be sustained. Up to now the growth in part-time work has helped to depress wages. With low hourly and weekly earnings, part-time workers have kept average wages down. But part-time work cannot keep on growing indefinitely. And the Bank also fears that the current climate of caution about wage increases is fragile; a few high pay settlements could produce a sudden clamour for more. The experience of the Eighties suggests that skills shortages will start squeezing in the next year or so. If these fears prove grounded, an inflationary wage spiral could be right around the corner, in which case an early cut in interest rates would risk fuelling demand and pushing prices up, too.

All of which, unfortunately, means the Chancellor must proceed with caution. In the past few weeks the Government has been blown hither and yon by electoral winds over Nolan, divorce and domestic violence. Yet the one claim John Major's government can make since 1992 is to have kept inflation under control as the recovery rolled on. Now is not the time for it to lose its nerve.