Time needed to judge Bank choice

By Hugh Pym
Economics editor, BBC News

To hold, to cut, or to raise - those were the awkward questions facing Bank of England policymakers this week as they mulled over their decision on interest rates.

They have opted to hold rates for the fifth month in succession.

That might look dull and predictable, but it could have been one of the most animated meetings since the Bank was given control over monetary policy in 1997.

And it could turn out to be one of the most critical decisions.

'Wishful thinking'

Consider this. Just a week ago, at the last possible moment before the Monetary Policy Committee (MPC) entered its self-imposed purdah before the meeting, one member Professor David Blanchflower, made some brutally frank comments.

He warned that if there were not sizeable rate cuts, the economy was heading for a deep recession.

Unemployment, he said, could rise to two million by the end of this year. He felt that Bank predictions of zero growth were "wishful thinking".

Only weeks before another member, Professor Tim Besley, had argued the opposite.

He has voted for interest rate increases to curb the surge in the cost of living at past meetings. His warning was that the UK faced a return to 1970s style inflation if the Bank of England did not hold a firm line.

And with inflation rising towards 5%, way above its 2% target, he had plenty of evidence to point to.

Peaking prices

However, Professor Besley and Professor Blanchflower cannot both be right.

It is fair to say that they are at either end of a spectrum of views on the MPC.

What we do not know yet is whether any of the other seven members have switched their votes away from a hold into the Besley or Blanchflower camps.

That will only become clear when the minutes are published in a couple of weeks time.

The rate holders will argue that there is enough pressure on inflation because of the credit crunch.

In other words, banks are tightening the screw on corporate and household borrowers without any need for the Bank of England to push its own rate up.

Hence the case is made to leave rates unchanged at 5%. They can come down, it's argued, when inflation has peaked and is on the way down.

Tough choices

But the chilling possibility is that either Professor Besley or Professor Blanchflower are correct in their analysis.

If the former is right, then inflation remains stubbornly high for a prolonged period, the Bank eventually has to tighten monetary policy more than it would like, and the economy will be forced into a deep downturn.

If Professor Blanchflower is right, then there will be a nasty recession because the Bank of England has kept rates too high for too long.

He points to the example of the US where there was aggressive rate cutting by the Federal Reserve.

We will not be able to judge until next year whether the MPC did the right thing by keeping rates on hold for a fifth month in a row.

Only then will it be clear whether the economy is heading for a soft landing with inflation brought under control or something more unpleasant.