View from City Road: Inflation picture is far from rosy

By all accounts Kenneth Clarke, the Chancellor, is still hoping to go the extra quarter and cut interest rates again, despite the concern of Eddie George at the Bank of England.

On the face of it, the April inflation figures - which were excellent - bolster his case. The underlying rate of 2.3 per cent is, in effect, the lowest since November 1967. Looking past the impact of Budget tax increases, which hit the headline rate, inflation appears benign.

Unfortunately for Mr Clarke, inflation figures reflect past price trends, not future ones. For signs of future inflation look at wages, money supply growth and unit wage costs. Here the picture is far from rosy. Average earnings are rising far more rapidly than might be expected, judging by yesterday's figures. The official line is that this is all due to bonus payments and therefore does not signal upward drift in wage settlements. Tosh. The reality is that wage settlement rates stopped falling not long ago. In some sectors they have begun a gentle rise.

Mr George has made it patently clear that he doubts the wisdom of cutting rates further while wages look perky. Yesterday's sharp fall in unemployment, despite an absence of employment growth, points to a labour market less loose than it once was. The longer-term fall in joblessness indicates that the recovery is firmly entrenched.

All this suggests the next move in base rates is much more likely to be up than down. What's happening in the US, where the Fed moved interest rates up by half a point on Tuesday, is a harbinger of things to come in Britain. The UK business cycle and financial markets are more closely aligned to the US than they are to the Continent, where rates are still falling.

Kevin Gardiner, Morgan Stanley's UK economist, thinks that to get to a neutral monetary position - one that is not stimulating the economy - base rates must be raised to 7 per cent. That's food for thought.