Leading article: The Bank is right to do nothing now

We won't know how the members of the Monetary Policy Committee of the Bank England voted yesterday until the minutes are published in a few weeks' time. But it is a fair bet that they were deeply divided over whether to start raising interest rates or whether to hold them. And so they should have been. The issue of rates is one of the most fraught questions facing the economic authorities today, and the most uncertain.

In the end the Committee decided to keep them once more on hold, as they have for the past 18 months. And they were right to do so. The recovery, although strong in the second quarter, is a fragile one. Most of the latest indications on house purchases, consumer confidence and car sales point to a weakening of demand and output. At the same time, the Bank of England has had to consider the wider context of a government determined to cut back public expenditure sharply and early. Raising rates at this moment, however marginally, could serve only to dent confidence further and drive a softening economy back into a recessionary one.

Caution, however, should not allow the Bank to minimise the very real problems of inflationary pressure building up in the economy at the moment. The Consumer Prices Index is now running at 3.2 per cent against the target of 2 per cent, as it has done for the past year. Some of the factors are of limited duration. The sharp fall in sterling is now tailing off and the currency is actually beginning to strengthen. The rise in grain prices has been fuelled by the heatwave in Russia, Uzbekistan and Kazakhstan. In the normal course of events, harvests should return to normal next year. Any upward pressure on prices should, on past experience, be held in check by the surplus of capacity and unemployment.

That at least is the theory behind the Bank of England's determined belief that, given time, inflation will come back down below its target rate next year. The trouble is that the Bank keeps saying this and keeps predicting an early fall in prices, but this has so far obstinately refused to happen. Currency depreciation may be partly to blame, but there are also more persistent underlying factors, not least the rise in commodity prices pulled by Asia's return to high growth. Grain, and hence food prices, may indeed fall back next year. In the meantime, however, they will be rising just as UK inflation is boosted by the increase of VAT to 20 per cent.

The fear is that, left unchecked, these cost pressures will work their way into public expectations, increasing wage demands and encouraging consumers to hunker down in their spending. Economically, persistent inflation can have a devastating effect over the medium term, as Britain of all countries has reason to know from its past. Politically, too, the impact on people's real incomes, their savings and their general optimism could be extremely damaging.

This is the tightrope that the Bank must now walk. On the one side there is the real terror of a double-dip recession, hastened on its way by rate rises. On the other side there is the nagging concern that inflation has gone on too long, and that the Governor of the Bank has had to write too many letters of explanation, for it be ignored any longer. Two years ago the Bank made the mistake of leaving it too long to lower rates in the face of the coming crash and had to act precipitately in consequence. It doesn't want to make the same mistake the other way round.

If George Osborne had not announced such savage reductions in public expenditure, the Bank might well have had to raise rates now. As it is, the prospect of budget cuts, the VAT rise and the signs of weakening growth have encouraged it to err on the cautious side. It will need to explain the reasons, however, if it is to hold rates, as it would like, through the medium term.