No big gestures please, Ken

Today will be the first time the Chancellor and the Governor of the Bank of England have met since the Budget. After failing to deliver huge tax cuts last month, Kenneth Clarke is under political pressure to cut interest rates instead.

Economic evidence has been mounting in favour of such a cut. Several factors suggest the economy is weak and in need of a boost. Economic growth and inflation are both lower than expected. Manufacturing industry looks fragile. Export markets don't look promising. The US and Germany face a slowdown and are likely to cut their interest rates in the next few months. The gloomiest economists even argue that Britain is heading back into recession and should cut its own interest rates as far and as fast as possible.

As always, however, there are countless other economists who take a different view. Down at the Bank of England, they are worried that inflation might be about to pick up. They fear that we could be set for an upward spiral in wage settlements next year. If this is right, inflation looms. Cutting interest rates now would only fuel price rises.

The trouble is that no one knows who is right. Economists are picking their way through a mire of conflicting evidence. We could be on the brink of a boom or on the verge of collapse. Worse, policy changes that Ken Clarke and Eddie George decide today will not have their full impact on the economy for about two years.

Faced with this uncertainty, what advice should Eddie give, and what action should Ken take?

The Bank clearly feels bruised by its encounter with the Chancellor in the summer. Eddie George called for an interest rate increase. Kenneth Clarke resisted and turned out, against the odds, to be right. The combination of being ignored and being wrong has damaged the Governor's credibility. As a result Mr George will be tempted to tone down his remarks and avoid any conflict.

This would be a serious mistake. The Bank of England is responsible for watching inflation like a hawk, resisting short-term political pressures, and advising the Government on how to meet its inflation target. It would be far more damaging to the Governor's credibility if he was thought to be second-guessing the politicians than if he were to be overruled once more.

It is the Chancellor who will make the final decision. Mr Clarke would be foolish to make large cuts in interest rates until we are sure that wages won't escalate. However, should interest rates in Germany or the US fall in the new year, then there would certainly be a case for following these with cuts of our own.

In the Budget, Mr Clarke gave voters a taste of the tax cuts they wanted without jeopardising the economy or the public finances. The Chancellor showed admirable political self-restraint in putting the national interest before the party interest.

He could do the same with interest rates. A small cut in interest rates now - perhaps a quarter of a point - is likely to have little impact on the risk of inflation while making a political gesture in the direction of a bigger cut next year. That would give Mr Clarke time to see which way the economy is really going.

Is the problem really inflation or recession? The economic jury is still out.