Shares volatility confounds rate expectations

What should the Monetary Policy Committee make of the downs and ups of the stock market? Most commentators have decided that it would not be politic to raise interest rates before the danger of another hair- raising nosedive in share prices has receded. So the expectation that the cost of borrowing would rise by a quarter point on Thursday has shifted to an expectation that it will not.

The judgement is indeed finely balanced. While share prices have been falling, the figures continue to show that the economy is motoring along at a smart lick. The jobs market is as tight as it has been for a decade and consumer spending is buoyant. The housing market is at worst steady and in some areas still steamy. There is no reason yet to think the stock market turmoil has affected consumer behaviour. To cap it all, manufacturing appears to be dusting off the impact of the strong pound as export markets in Europe recover. Normally, the case for the next rise in interest rates would be overwhelming therefore. The caveat is whether an increase in borrowing costs at this time would destabilise equities again. If the Bank of England is to hold its fire this week, this is the justification it will have to give. Market turbulence might be enough to justify another month of wait and see.

As always, the decision hangs on whether the possibility that inflation will remain low without action outweighs the benefits of opting for earlier but smaller increases in interest rates. The really encouraging thing about the policy debate is that the advocates of higher rates are actually so close to the wait and see brigade. Almost nobody expects rates to have to rise to 8 per cent or beyond. In Britain's economic history, this is progress indeed. But given the inheritance - too little action on interest rates before the election and a far smaller reduction in retail price inflation than could have been expected against such a favourable world inflation background - the Bank ought to strike straight away. The factors driving down the UK stock market are really nothing to do with the position of our own domestic economy or its inflation outlook. If it later turns out, as some commentators think, that the world is indeed sinking into a deflationary spiral, a quarter point on interest rates now would not matter either way in any case.