The Threadneedle Street stitch-up: What is all the more amazing is that John Major has furiously opposed independence for the Bank of England. Yet this is what he has presided over

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The Independent Online
A week today the Treasury will publish the minutes of the May monetary meeting between the Governor of the Bank of England and the Chancellor of the Exchequer. It will be the third month that this has happened, and it is a very extraordinary thing.

In April, quietly, through a reply to a written Parliamentary Question, Kenneth Clarke handed over the primary responsibility for the conduct of monetary policy to the Bank by saying that in future the minutes of his monthly meetings with the Governor, Eddie George, to set monetary policy would be published with a six- week lag. In effect, although possibly not by design, the Chancellor instantly gave the Bank at least a form of independence.

The direct consequence is that it is now almost inconceivable that the Chancellor could take the risk of forcing through a cut in base rates which the Governor believed was taking a chance with inflation. He would know that even if the markets initially gave him the benefit of the doubt, within a few weeks nemesis would come. Long- term interest rates, which represent the markets' view of future inflation, would rise and, in self- fulfilling prophecy, sterling would be hammered into the floor.

The proof already exists. Rather bravely, Mr Clarke added a touch of retrospection to his April edict, permitting at the time of his announcement the publication of the February minutes. They made fascinating reading. Throughout, the Chancellor emphasised his concerns that the April tax increases might undermine the recovery and that there was a danger of excessive caution. Mr George's view was that the economy was growing strongly and there was no evidence that the Budget measures would have the effect that the Chancellor feared. The minutes summed up: 'To cut rates now in advance of this evidence would run a risk of higher inflation and some loss of credibility, and he (the Governor) strongly advised against.'

In the end, they compromised on a cut of 0.25 per cent, grudgingly conceded by Mr George. By the time of the next monetary meeting, the pound had depreciated by 2 per cent and gilts had taken a bath. Later, the Bank observed that the markets 'were surprised by its (the base rate cut) precise timing on 8 February, shortly after the quarter point rise in the federal funds rate and in the light of the cautionary note in the Bank's February Inflation Report'. This is central bankspeak for: 'You ignored our advice and got caned.'

In the minutes of the next two meetings, it is clear that the power relationship has turned in Mr George's favour. The Governor observes that while long-term interest rates had risen sharply everywhere, 'there had been particularly large adjustments in the UK; and inflation expectations incorporated in gilts prices had increased. In the circumstances it was important to build up credibility in monetary policy and reduce inflationary expectations, so that there was no feed-through to price- and wage-setting behaviour.' The Chancellor somewhat lamely replies that he feels that the markets had overreacted to events. But he quickly comes into line, accepting that this was not the moment to contemplate any further cut in interest rates. As the Prime Minister might put it, game, set and match to the Governor.

The Chancellor and the Prime Minister may in theory retain the sole right of initiative in setting interest rates, but in practice the politicians of Downing Street have made themselves subservient to the technicians of Threadneedle Street. What makes this all the more amazing is that John Major has always furiously opposed independence for the Bank of England. Yet, apparently without realising it and without getting any political credit for it, this is precisely what Mr Major has presided over.

Quite how it came to pass is something of mystery. It is clear, however, who set the ball rolling. In the immediate aftermath of the pound's expulsion from the ERM, Norman Lamont realised the urgent need to restore some credibility. Believing that politicians were not to be trusted to run a discretionary monetary policy, he strongly made the case for giving the Bank full independence, only to be met with blank indifference from the Prime Minister. However, Mr Lamont realised that if the front door route to independence was closed, he might get at least some of the way by going round to the back door.

Mr Lamont's crucial insight was that the more transparent the conduct of monetary policy could be made, the more accountable it would become. He also realised that if you allowed the Bank to produce its own report on inflation, with skilful use it could become a powerful restraining hand on any Government tempted to debauch the currency for short-term political ends. He introduced a commitment to issue detailed justifications for any changes in interest rates, the publication of the Treasury's Monthly Monetary Report and the the publication of the Bank's quarterly Inflation Report.

Since then, his successor has made the Inflation Report even more the Bank's own work, allowing the Treasury sight of it only in its final form. Also, since November, the Bank has been given responsibility for the precise timing of interest rate changes to try to lessen the temptation of politically-motivated rate cuts.

The publication of the minutes, however, has taken even Mr Lamont by surprise. He fears that if the Chancellor thought the Bank was likely to come between him and the political imperative, there would be a prior meeting at which no minutes would be taken. I think he is wrong. The Bank is in deadly earnest. As one senior Bank official put it: 'We're not going to play games. If you do that, you might as well pack the whole thing in.'

What has happened is irreversible. The only question is when, not whether, the Bank of England achieves formal independence. If the Bank proves its credentials over the next couple of politically testing years, a canny Labour leader could trump the Tories on inflation by making full independence a manifesto commitment.