If Mervyn King really did reach a gentlemen’s agreement with the Chancellor to refrain from criticising the Government’s fiscal policies in the run-up to the election, he came dangerously close to breaking it last night.
In his first public speech this year, the Bank of England Governor was diplomatic in his delivery. But the message was clear. He expects the Chancellor to deliver some serious detail on plans to cut the deficit before the election.
This was not simply political stirring from Mr King. Over the past year, the Bank has taken drastic steps to prevent economic meltdown, including cutting interest rates to historic lows and pumping billions of pounds directly into the economy through “quantitative easing”.
The tricky challenge now facing the Bank’s Monetary Policy Committee is to pick the right time to start unwinding these measures.
There are real doubts about how far quantitative easing has actually improved credit conditions rather than just flooding bank reserves. Key measures of money supply are still growing at stubbornly slow rates. But Mr King declared that the strategy had averted a “potentially disastrous” monetary squeeze.
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The road ahead for the MPC now gets more treacherous. If it raises interest rates too soon, the economic recovery could be snuffed out. If it waits too long, it could start inflating future asset price bubbles.
Mr King is relaxed about the sharp rise in inflation in December, reported yesterday, calling it a temporary spike. Part of the reason that he is so sanguine is the knowledge that the inevitable fiscal tightening will act as a dampener on prices.
But the sooner the MPC has detail about the scale of tightening, the more chance it has to steer the right course for monetary policy.
To ram home the message that monetary policy cannot be determined if the MPC does not have all the relevant information to hand, Mr King likened the MPC to the owners of Quantitativeasing a successful five-year-old chestnut gelding owned by JP McManus.
All were waiting for “race conditions” to become clearer before deciding if quantitativeasing should have another outing this year. Over to you, Chancellor.