Leading Article: The Bank must cut interest rates, and quickly

MOST ECONOMISTS seem to expect the Bank of England's Monetary Policy Committee to leave interest rates at their present level after its two-day deliberations, which begin today. There are various reasons for this. There is still a general feeling that the Bank has to prove its "toughness", establishing its anti-inflation credentials in the markets. The Bank is naturally cautious about making a rapid U-turn on rates, especially at a time of such financial instability.

More specifically, earnings growth in Britain is still higher than the Bank would like, anxious about the implications of that for its ability to meet the Government's inflation target. Some on the committee fear a repeat of mistakes made in the wake of "Black Monday" in 1987, when rates were cut too soon and too deeply, allowing inflation to get out of hand.

These fears should no longer dominate policy. For one thing, the situation now is not like that of 1987. Global financial turbulence is an established deflationary force, with evidence emerging all over the world that recession, not inflation, is the foremost danger to prosperity.

With South-East Asia's economies still contracting, a wave of cheap imports and cheaper labour will break over the Western economies in the next year. Even more important, export markets will shrink, and world trade will become further depressed. Alan Greenspan, the chairman of the US Federal Reserve, is no dove on inflation; but even he has begun to hint that interest rates' next move will be down.

Similarly, on the domestic front no one has to look far to find signs of a slowdown. Up to a few weeks ago it was possible for the Bank to point to a vigorous service sector to justify higher rates, to restrain the boom in those services; now the sector seems about to follow manufacturing into stagnation. Earnings growth is slowing; high-street sales are flat; house prices are falling. In fact, as both trade unions and business leaders have argued in talks with the Government, British economic growth will slow over the next two years to almost nothing.

As Keynes once said, the prevailing view among economists is often dominated by the ghosts of the previous generation. In this case, central bankers are haunted by memories of the Seventies, when inflation roared out of control. But the situation is very different now. Labour market reforms, free investment flows and technological advance all make inflationary spirals less likely. Real interest rates are historically high; we are entitled to ask whether this can be justified, if everything central banks have told us about the advantages of liberal capital markets is true.

The economy is slowing so quickly that a decisive cut in interest rates, of half a percentage point, should be on the agenda. This would prevent more money flowing into sterling, aiding its fall on the foreign exchanges and bringing relief to exporters. It would mean our economy moving marginally more into line with those in the euro bloc, aiding our ability to join them, should we wish. A rate cut would also stabilise the jittery stock market.

There is an international aspect to the decision, too. Capital flight is forcing interest rates up around the world, as governments compete to attract money into their currencies. Lower interest rates in Europe and the US are vital to restore confidence and reverse this process. The Prime Minister has called for a meeting of the G7 nations to discuss the world's unstable financial system; Britain could now give a signal of determined Western economic expansion, just when the developing markets of Russia, Latin America and Asia are crying out for it.

In fact, it is difficult to make any case for interest rates being maintained at their present level: the time is right to loosen monetary policy. The Monetary Policy Committee should cut interest rates, and quickly.