The decision by the Bank of England to hold UK interest rates at 6% came as no great surprise to any...
The decision by the Bank of England to hold UK interest rates at 6% came as no great surprise to anyone. A survey of City economists before the announcement showed just one optimistic, and probably foolish, soul forecasting a cut in rates.
That is odd. After all, in the US the Federal Reserve had just set a strong precedent by cutting interest rates there by half a point. The UK economy is not short of warning signals of an imminent slowdown. There are lots of reasons why interest rates could, and probably should, be cut.
But the City's economists know their man. In the nearly four years since the Bank of England was given independence to set interest rates, its governor, Eddie George, has proved himself a dour anti- inflationary hawk. He is a man who never saw an economy which didn't strike him as on the verge of an inflationary spiral, and who never came across an interest rate he didn't want to jack up.
George may not realise it yet, but that is dangerous attitude. This is the first big test the bank has faced as an independent entity. If it flunks it, the bank must expect questions to start being asked about whether giving it independence was the right move - questions it might find hard to answer.
For the UK, an independent central bank is a novel concept. Interest rates are the key tool for managing the economy - lots of people quite rightly have trouble understanding why they should be controlled by an unelected banker, rather than an elected politician they can throw out of office if they mess things up.
The key question for the bank is, has the management of the UK economy been better because of its independence, or would it have been better to have left power over interest rates with the Government? We are about to find out.
If the bank can engineer a soft landing for the UK economy, it will solidify support for its independence. If, however, it manages to engineer a painful recession, support for its independence could evaporate very quickly.
Many of the same signals that prompted Greenspan to make an emergency cut in interest rates can be seen in the UK. Inflation has fallen to just 2.2%, below the Government's target rate. Growth has dropped to under 3%. House prices, a key indicator of the health of the UK economy, dropped by 1.1% last month. Job vacancies are falling. On the day that the decision to hold rates was announced, many of the UK's leading retailers, such as Next, Matalan and Great Universal Stores, saw their share prices tumble on reports that Christmas trading had been disappointing.
It is clear that UK consumers are growing nervous, and are already reining in their spending in expectation of a downturn. Those are all classic signs that a downturn is coming.
Most of the market believes there will be a cut of a quarter or half point in February or March. So why wait? A brave monetary policy attempts to get ahead of events, shaping and controlling them, not just reacting.
Only the Bank of England remains obstinate, waiting until it is in the midst of a full- scale recession until it cuts rates, and forever slaying inflationary dragons that no longer exist.
There are two ways the bank could lose its independence. Either it could come back under the control of the UK Government, with the Chancellor reclaiming the right to set interest rates.
Or it could see its powers usurped by the European Central Bank if the UK decides to join the euro. Both outcomes would be a lot more likely if the UK economy goes into a recession - which makes it surprising that George and the Monetary Policy Committee are not working harder to avoid that outcome.
Matthew Lynn via the Bloomberg London newsroom
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