Inflation rise: Grim and grimmer

It would be easy enough for Mervyn King and his eight colleagues on the Bank of England's monetary policy committee (MPC) to bring inflation back down to the government's 2% target. They could push up bank rate, slow down the economy, lengthen the dole queues and cause more firms to go bust. In the past, that is the way upward pressure on the cost of living has been curbed. No doubt a dose of the same medicine would work again.

And, it should be made clear, there is a serious argument for administering one. Figures out yesterday showed that inflation is running at 4% and is unlikely to have peaked. As Mr King noted yesterday, the Bank has been taken unawares by the scale of the increase in global food and energy prices. What is more, Britain's record of dealing with inflation is hardly an unblemished one. Harold Wilson reacted too slowly to the quadrupling of oil prices in 1973-74, and saw inflation rocket to almost 27%. Nigel Lawson lost control of the economy in the late 1980s, with the result that interest rates had to be cranked up to 15% in order to bring inflation down from a peak of nearly 10%.

Those economists who, like the MPC's Andrew Sentance, favour an immediate increase in bank rate believe a stitch in time will save nine: failure to tighten policy now while inflation is still relatively low could mean that much more draconian action will be needed later. They also point out, quite correctly, that bank rate has been at 0.5% for the past two years: this is an emergency low level never seen before in the Bank's 317-year history. Giving interest rates a slight upward tweak would do little damage to the economy but would do wonders for the Bank's inflation-fighting credibility.

However, judging by his letter to George Osborne explaining the Bank's failure to hit the inflation target, the governor has yet to be persuaded of this argument. He is right to be wary, for there are solid reasons why it would be a mistake to tighten policy too soon. The Bank, for example, has no policy levers available that could affect the cost of crude oil or the price of food on global markets. Mr King noted yesterday that inflation would probably be below 2% if the impact of higher VAT, the fall in the value of the pound and the increases in commodity prices were stripped out. That may sound a bit like an under-pressure Premier League manager telling the press that his team would be top of the table had they not lost home and away to Manchester United, Arsenal and Chelsea. But it is still a fair point. The MPC can only counteract the impact of global inflationary pressures by increasing the deflationary pressure on an already weak domestic economy. Even then, there would be no immediate impact on inflation, because it takes time for changes in monetary policy to work their way through the economy. It would not be until the end of this year or early 2012 that the effects of decisions taken by the MPC now would start to be felt, and by that time inflation will be falling anyway. Decisions on interest rates are supposed to be taken looking at the road ahead rather than with eyes fixed on the rear-view mirror.

The next 12 to 18 months are going to be tough for the UK, as David Cameron frankly admitted earlier this week. Taxes have risen, inflation is squeezing real incomes, credit rationing for first-time buyers means the housing market is flat, and the big cuts in public spending have yet to bite. Mr Osborne, in his published reply to Mr King yesterday, made it clear that he is in no hurry to see interest rates pushed higher. It is not hard to see why. The chancellor has raised taxes and announced spending cuts precisely so that the Bank can keep monetary policy loose. To impose the toughest spending round of the postwar era and then to raise interest rates simultaneously would make an already grim economic year even grimmer. The MPC should stand firm.