Rate rises and reputations

WHEN you study economics at school, it is all about lines on graphs. One thing they don’t teach you, however, is that Mervyn King will always be behind the curve. He was stuck there before the onset of the credit crunch and didn’t move forward sufficiently quickly during the banking crisis. It is no wonder that the Bank of England Governor says he cannot see “any way out” of the current rise in inflation; he may not have seen a way into it.

The rise in inflation to four per cent in January, twice the level of the official target, should not be seen as a surprise. Britain’s cut in interest rates to a record low of 0.5 per cent, which was necessary to prevent a recession turning into a depression, is now beginning to look out of date as the higher rate of VAT pushes up prices on the high street.

A gradual increase in the base rate has become inevitable, even though it will pile pressure on millions of mortgage-holders, because the alternative is stagflation – a period of rising prices and low economic growth that is every economist’s nightmare.

Such a bubble must be avoided if Britain is to have much chance of escaping from the threat of a double-dip recession. The decline in total output in the final three months of last year was driven by more than just the appalling weather. It reflected Britons’ tightening of the purse springs amid Government spending cuts and the fear of affect in the long-term.

Yesterday’s Bank of England quarterly report, which warns that inflation could soar to nearly five per cent, only underlines the uncertain outlook. It has left Britain’s legion of savers fearing that consistently rising prices will hit the value of their assets. It is no wonder there are splits among the members of the Bank’s interest rate-setting committee and these have been illustrated by their comments during visits to Yorkshire. Their targets for this year should be limited to stimulating growth and returning monetary policy to some kind of normality.

There can be no winners if Britain gets stuck in a period of high inflation. A modest interest rate rise this spring would represent a flexible move by a confident central bank trying to anticipate spending patterns, rather than simply following them. It would even put Dr King back in front of the curve.