Business Outlook: Bank's stitch in time should save nine

On the stitch in time saves nine principle, the Bank of England was absolutely right to put up short-term interest rates by a quarter point yesterday to 7.25 per cent. A number of small increases in interest rates now should dampen the economy and head off the need for larger ones later.

All these decisions are in the end largely a matter of judgement and no doubt there were some on the Bank's monetary Policy Committee who opposed this move. We'll have to wait six weeks to publication of the minutes to find out just how much opposition there was and where it came from.

Even so the case for raising rates now, though not overwhelming, is certainly compelling. The economy continues to grow at a fair old lick, and while inflation seems to be in abeyance right now, it won't be long at this rate before it resurfaces. In some areas of the economy, notably house prices in the South-east and wages in high skill jobs like IT, it is already racing away. What is more, the strong pound and some deflation in producer prices may be helping to disguise a far more alarming inflationary picture in the economy than the one we are seeing. Those who believe otherwise, including the former chancellor Kenneth Clarke and the British Chambers of Commerce, are just kidding themselves.

Indeed, the only real surprise about yesterday's decision is that it appears to have been so unexpected in the City. Plainly this column, which has been warning of the need for another rise in interest rates, is not as widely read as it should be. True, we don't know yet in any detail what mechanisms and guidelines the MPC uses in coming to its interest rate decisions, so there is bound to be some confusion. There should be some illumination on that front in next Wednesday's inflation report.

But we do know what the inflation target is and you only have to look at the last inflation figures to know we are above it, albeit within the one percentage point band either way the Government has given the Bank as leeway. Furthermore, those who believed that the recent fall in the stock market might persuade the MPC to alter its judgement because of the risks of causing another precipitous sell-off can't have been reading the literature.

The MPC only has discretion to stray from the inflation target if there is a serious shock to the economy. Scary though the events of the past two weeks have been, a 9 per cent fall in a market which had already gone up nearly 30 per cent on the year, can hardly be described as that.

Nor should recent statements by either the Chancellor or the Governor about the need to maintain a parallel track and monetary policy with single currency countries, have been read as an indication that short term interest rates would be moved rapidly into line with these countries. Rather the reverse. What the Governor and the Chancellor were talking about was the common European objective and purpose of low inflation growth. Because we are at a different stage of the business cycle, that objective for the time being requires a quite different monetary policy.

In other words, yesterday's decision, unpalatable though it might have been, was also entirely predictable. A quarter point doesn't in any case make a huge amount of difference either way. But it does send out an important signal - that the Bank is serious about keeping the lid on inflation.