View from City Road: Lamont's revenge could be sweet in City's ears

Hell hath no fury like a former Chancellor scorned. Whether it was Lords Howe and Lawson or now Norman Lamont, a spell at the Treasury seems to do little to impair the capacity to wound. The brickbats, moreover, come dressed with a light garnish of intellectual high-mindedness, namely the espousal of the independence of the Bank of England. Sadly, this worthy policy shows worrying signs of becoming like other badges of liberal respectability, such as open government - a policy passionately advocated in opposition and dispassionately forsworn in office.

The source of Mr Lamont's evident bitterness is not hard to find. His fate is one of the outstanding modern examples of the unfairness of political life. The former Chancellor was appointed to his office when the pound had already joined the European exchange rate mechanism. As Treasury Chief Secretary to John Major's Chancellor, he had been merely a spectator of the great policy decisions that shaped the second half of the recession. Although Mr Lamont became the accomplice of our European and fixed exchange rate policy, he was never its progenitor. Personally, indeed, he had been sceptical about its merits.

As he implied yesterday, the major culprits of the British recession were Margaret Thatcher and Nigel Lawson. Between them, they had stoked up demand with interest rate and tax cuts to such a point that it woefully outstripped supply. Prices accelerated. Imports soared. After the summer of 1988, the name of the game was reining in the boom. A recession was inevitable. But it was Mr Major who made the long-term problems worse by failing to face up to hard choices.

Mr Major ignored the Treasury's advice at the beginning of 1990 to raise interest rates to 16 per cent. Then he decided that he could not raise taxes in the 1990 Budget. Having flunked the two most obvious ways of tightening economic policy, he resorted to the soft option of talking up the pound by teasing the markets about imminent membership of the exchange rate mechanism. When we did join in October, sterling was 9 per cent higher than it had been in March. This certainly squeezed import prices and inflation, but at the cost of making life harder for our exporters.

It was also Mr Major who decided on the timing and manner of our ERM membership. In common with many others, he underestimated the impact of German reunification on German interest rates, and hence he underestimated how high British interest rates would have to be to keep sterling in the system. But he made two more avoidable mistakes.

The first was an arrogant failure to consult our partners, particularly the Germans, about an appropriate parity for sterling. This was to backfire badly when Britain needed support. Why should they help defend a level for the pound which they had not approved? Mr Major also miscalculated badly by cutting interest rates on the day we entered, thereby arousing suspicions in the markets that the Government was not to be trusted on inflation. Interest rate cuts then had to come more slowly.

This, then, was the inauspicious background when Mr Lamont took over as Chancellor in November 1990. From then until last summer, he hardly put a foot wrong within the constraints that he had been given. The markets were appeased so successfully that British interest rates could be cut to 10 per cent, only a sliver above German ones. But it was not enough to forestall deepening unease about the depth and duration of Britain's debt-driven recession.

Despite his then private, and now public, agnosticism about Britain's membership of the exchange rate mechanism, Mr Lamont was the face of the defence of the pound through the summer of 1992. His real fault was not any tactical error in the pursuit of what was the Prime Minister's economic policy, but his public presentation. Whether before a wide public or the City, Mr Lamont was unable to communicate the conviction and confidence necessary for his task.

When the Government's policy blew apart with Black Wednesday, it was inevitable that all his firm commitments to hold sterling stable should come back to haunt him. His credibility was in tatters. That he struggled on until last month, rather than falling on his sword in the immediate wake of the ERM debacle, is testament to the Prime Minister's loyalty, and the Prime Minister's knowledge that there but for the grace of God went he.

What should the markets make of Mr Lamont's revenge? The City has not yet taken on board the potential political impact of Mr Lamont's remarks. It is at least arguable that he has done no more damage to John Major than he has managed to do to himself. As the least popular prime minister since polling began, Mr Major does not have far to fall.

There must, though, be a chance that the Prime Minister will go before the end of the year. In these circumstances, much the same calculation should probably apply to a change at 10 Downing Street as at the house next door. Despite the increased potential for Tory fratricide that a further Clarke elevation might cause, it is hard to see the change doing other than improve the Government's public standing.

In the true blue City, that in itself would normally encourage the financial markets. The prospect of a more self-confident government tackling its pounds 50bn budget deficit would be an added bonus.