No other choice the Bank could make on interest rates

Jul 10 2008 By Nevill Boyd Maunsell, Economics Editor

Consider. What would have happened if the Bank of England had upped interest rates, as plenty of sensible people thought it would just ten days ago after governor King and a bunch of his acolytes had a tough-sounding session with the Treasury Select Committee?

Well, the Footsie might have imploded by more than the 123 points it actually lost. Otherwise, not a lot.

In the real world, LIBOR, the basis on which banks lend to each other, insofar as they lend to each other at all, has lost touch with the Bank’s official base rate.

Then what would have happened if it had cut the rate?

The Footsie would certainly have sunk by more than 123 points amid cries that the Bank had panicked and/or knew something dreadful that nobody else knows.

Otherwise, again, not a lot.

Real-life rates would have become more inclined to stay put, or edge down, rather than go higher, but what used to be a mechanistic link is broken.

Indeed, these real-life rates are doing some of the Bank’s inflation-fighting for it.

So is the mayhem in the housing market, though the Bank would be wise not to crow about it.

You can argue, too, that money sucked out of the economy by the petrol, energy and food prices that are fuelling this inflation are themselves disinflationary – provided the victims, don’t go on strike to protect their standard of living.

That may not be for ever. Ernst & Young reckons the average British household is 15 per cent worse off than five years ago. For the rest, tracker mortgages which are contractually linked to base rate would be cheaper if the Bank had cut its rate.

But there would not be any more of them.

It is lack of mortgages, not their price, that has stifled the housing market. The Bank’s £50 billion-plus special liquidity scheme has never filtered through into mortgages.

Nor will it for a while. Bankers who vied with each other to find borrowers to take their money while house prices were rising fast enough to cover up their inevitable mistakes, have had a nasty fright.

Now house prices are falling they are lending only to people with a nice fat deposits to cover a future fall and then on terms that give them ample margins.

They don’t believe in the security of bricks and mortar any more.

A cut would possibly have checked any inclination on the part of the banks to pare back their lending to non-financial, non-property, non-construction companies. Fortunately there is barely a hint of that so far.

The over-riding issue for the Bank is its own credibility.

After all the fierce talk this past month, a cut would have been taken as a signal that it had lost its nerve and gone soft on inflation, like the Fed in the States.

Put that way, there was not much choice.

There was little to gain, and daunting risks, in doing anything either way. Doing nothing was the no-brainer.

In two weeks’ time, when the Bank publishes the minutes of this week’s committee meeting, we shall see how many of its brainy committee members voted otherwise.