Why ceding control of interest rates was Brown’s biggest error

I have always had a suspicion that, in May last year, Gordon Brown’s initiative as new Chancellor to pass control of interest rates to the Bank of England had less to do with a radical commitment to central bank independence and everything to do with political expedience.

Call me a cynic, but I believe that, back in those days, when New Labour thought anything was possible with a Commons majority of some 180, there was a serious expectation that Britain would make an early entry into a single European currency. No more petty, Little Englander in-fighting over Europe, New Labour was about to lead Britain into an exciting future in EMU.

An immediate problem, however, would be the management of a British economy that would have to perform to the criteria required of EMU. We had already witnessed how the luckless John Major and the wretched Norman Lamont had suffered on Black Wednesday, as they threw interest rates up and down in a single day in 1992 in a wild attempt to keep the pound within the narrow band of the Exchange Rate Mechanism.

Black Wednesday was a political warning from the Conservative past. The fear had always been that monetary union would lead to high interest rates and unemployment. How the new Chancellor, Gordon Brown, must have feared the consequences of high interest rates in the wake of Britain’s entry into the single currency – and how much better it must have seemed for the Bank of England to take the flak for interest rates, rather than for the Government that took the single-currency decision to do so.

That was then. Less than a year after the historic New Labour victory at the polls, early entry appeared rather less of a good idea. You will recall that during last year’s conference season Brown backed off from a policy of early commitment to monetary union. British industry howled that 2002 would be too late, but to no avail – first-wave entry had been ruled out.

How piquant it was, therefore, to hear the Chancellor’s plea to the Bank of England’s monetary policy committee (MPC) during his address to the International Monetary Fund last week, when he halved his forecast for British economic growth next year. And how he must have wished that he had retained the power to adjust interest rates to protect the pound and equity markets.

Had he done so, we would almost certainly have had a 0.5 per cent cut in base rates, rather than the grudging 0.25 per cent that the MPC allowed. It wouldn’t have saved the markets from the effects of a diving dollar, but it would have made life easier in London. And, remember, even a 0.25 per cent cut by the MPC was not a forgone conclusion.

Poor Chancellor Brown had given away political power over interest rates, was left to beg for a cut from the MPC and would not even enjoy the political fruits of the early EMU entry for which he had divested interest-rate power in the first place.

Few in British business will have any sympathy for him. He has neither delivered our exporters the undoubted benefits that the euro will bring to those European governments that are signed up to it next year, nor the lower interest rates that our manufacturers and retailers crave, to provide some cushion against the forthcoming recession.

The twin prongs of euro-exclusion and higher interest rates will have delivered a jab at British business in a variety of ways. No more so than in the retail industries. The launch of the euro won’t be a doddle in a deepening European economic crisis, but Europe is a nightmare for retailers already – when Marks & Spencer backs off a 2.2bn European expansion plan, out of concern for its share price in London, the writing’s on the wall for the British retail industry.

I wrote here in the New Year that, after generally miserable Christmas and sale seasons, we could anticipate a period of consolidation among retailers. That consolidation has not developed to the degree that I anticipated, but it is there to be found if you look.

The merger of Thomas Cook with US-based Carlson, for example, demonstrates consolidation in the UK package-holiday retail sector. There will be more consolidation to come in this industry. The dominant factors are Thomson Travel and Airtours. First Choice, holding third place in the market, has no retail presence. One way or another, it soon will have.

But, as Chancellor Brown tells us, next year will be tougher than we thought. Consolidation in the retail and service sectors may not be sufficient – at the very least, it might now all look too little, too late. Middle-class jobs are widely at risk and that means even darker days on the High Street.

Take London. Spending growth slowed from 14 per cent in 1996 to eight per cent last year. It will be heading in only one direction this year and next. Retailers, not to mention restaurants and hotels, will soon be going to the wall.

Interest-rate policy will be blamed as part of the reason. And, as he can now regretfully say himself, there’s not a blind thing the Chancellor can do about that.

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