Election '97: Chancellor rejects rise in interest rates

Kenneth Clarke, the Chancellor of the Exchequer, is unlikely be persuaded to raise interest rates when he meets Eddie George, the Governor of the Bank of England, for what could be their last monthly monetary meeting next Thursday. Whatever it accomplished for his image as a prudent manager of the economy, it would also trigger a round of mortgage rate increases just three weeks before the general election.

The Bank has now been at loggerheads with the Chancellor for six months. Many City economists see Mr Clarke's ability to shrug off the Governor's advice to raise the cost of borrowing during the pre-election period as evidence that politics ultimately outweigh prudence under the monetary arrangements introduced after the crisis over the Exchange Rate Mechanism (ERM).

Mr Clarke's refusal to take the Bank's advice means that interest rates and mortgage rates will go up after the election, and perhaps by more than they otherwise might have. If Gordon Brown is the new Chancellor in a Labour government, he is expected to agree to an increase of a half a percentage point, perhaps as early as the 7 May meeting.

This would prompt the big mortgage lenders to increase their rates. Some are expected to start raising the cost of fixed-term mortgages as early as this week.

This latest episode is not the first time Mr Clarke has stood firm against the Bank, but it is the longest clash they have had.

Behind the row lies the fact that the Government has not met its inflation target for nearly three years. Although there is a fair chance that figures next week will show underlying retail price inflation approaching its target of 2.5 per cent, it is widely expected to remain on target for a few months at most.

Since the monthly meetings were introduced at the start of 1993, he has turned down Mr George's advice on four previous occasions. Mr Clarke turned down Mr George's recommendations to raise rates in May 1995 and September 1996, and cut rates against his advice in January and June 1996.

The Chancellor has also been playing down the Bank's argument, ever since the quarter- point base-rate increase last October, that the economy is growing fast enough to pose a serious threat of higher inflation in future. The strong pound has been his excuse for overruling the evidence of an inflationary boom.

Mr Clarke has got away with ignoring the Bank of England for two reasons. One is that his first clash with the Governor, in May 1995, turned out to be a lucky call. The economy did, in fact, slow down without the higher interest rates the Bank had called for.

The second reason, however, is that the financial markets are so sure there will be a new chancellor who will take the appropriate action next month that a short delay will not do serious damage to the economy.

There is clear evidence of a consumer boom and faster pay growth, but the impact of the pound's high exchange rate on exports will offset the effects on inflation.