Outlook: How independent can the Bank be?

JUST IN case you'd forgotten, it's worth recalling that these days interest-rate decisions are taken by the Bank of England, whose Monetary Policy Committee is supposed to determine them independently of the Government but according to a Government-set inflation target. Both Gordon Brown and Tony Blair have stopped short of saying it outright, but they want the MPC to cut rates sharply after this week's two-day meeting. Such is the gravity of the worldwide economic crisis, they suggest, that a cut of as much as one percentage point wouldn't be amiss.

As if to emphasise the point, the Government last night halved its forecast of growth for next year to just 1 per cent. The effect of this is to damage its projections for the public finances and further increase the pressure for an interest rate cut, for in present circumstances the Government is hardly going to raise taxes to make up the difference.

Unfortunately, neither the Chancellor or the Prime Minister are meant to make overt interest rate demands. They've only recently made the Bank of England independent, and it would amount to an admission of bad policy if they were to say that they know better how to set rates than the MPC. So they've communicated their will in time honoured fashion - via hints and spin. You may say that the Chancellor wants a sharp cut in interest rates, his aids have told journalists at the IMF annual meeting in Washington, we couldn't possibly comment.

All this must be irritating in the extreme for Eddie George and his deputy at the Bank of England, Mervyn King. What's the point of us being independent, they might reasonably ask the Chancellor, if you are going to bounce and bamboozle us into making the decisions you want to see.

As if happens, growing signs of a pronounced slowdown in the UK economy over the past month are probably sufficient to justify some kind of a cut, though yesterday's earnings figures neatly point up the dilemma -- despite the slowdown, there are still a number of strong inflationary pressures making themselves felt out there. However, the size of any such cut is unlikely to be enough, either for the Chancellor or the markets. They believe that the nature of the crisis afflicting financial markets warrants much more.

The tragedy of it all is that ministers are almost certainly right about this, and yet the Bank of England is locked into a very tight remit of the Government's own making.

Does the MPC ignore the remit, knowing that the Government thinks the nature of the crisis is such that the inflation target is no longer relevant? Or should it take the view that the inflation target is sacrosanct, that the present apocalyptic warnings about the world economy are exaggerated, and that it is going to be sorely punished if it misses this early opportunity in its independent reign finally to exorcise the inflation demon from the UK economy?

It's a tough one, isn't it? The honest thing for the Government to do in such circumstances is to invoke the Bank of England Act, which allows ministers to take back control of interest rate decisions in extremis - or if satisfied that such action is required in the public interest and by extreme economic circumstances. The Act does not define what extreme means or who decides it. But presumably if the Chancellor, thinks the nature of the crisis requires an interest-rate cut greater than that justified by the inflation target, then that might amount to an extreme.

Even so, to reimpose political control so soon after ceding it would be an admission of failure and the Chancellor would be very reluctant to take such action. So for the time being he's going to have to hope that his not-so-subtle hints do not go unheeded by the MPC.