We're paying the price for Gordon Brown's fairweather policies

Liam Halligan, Sunday Telegraph 22nd June, 2008

One of the Bank of England's main jobs is to maintain "financial stability" by helping to supervise the banking system. On top of that, of course, the Bank's Monetary Policy Committee sets interest rates.

The manner in which both roles are executed - regulatory and monetary - matters hugely. The quality of the Bank's decision-making affects practically every British citizen.

For some time now, the Government - through bad policy and neglect - has made both of the Bank's tasks harder. But last week - as the "credit crunch" blame game climaxed and inflation hit a 16-year high - ministers seemed to go out of their way to make the "Old Lady" look bad.

Such conduct isn't only unseemly, but deeply damaging. The more ministers criticise the Bank, and the more their sleep-deprived spin-doctors "brief against" the Governor Mervyn King, the more they damage the MPC's ability to fight inflation and the UK's general financial credibility.

In 1997, in his first act as Chancellor, Gordon Brown gave the Bank "operational independence", created the MPC, and switched interest rate powers from the Treasury to Threadneedle Street.

At the same time, partly to smooth feathers in Whitehall, Brown set up the Financial Services Authority, a Treasury satellite, to oversee lending institutions. For decades, oversight of our banking system had been split between the Bank (providing brains and inside knowledge) and the Treasury (political authority and cash). But since 1997, the FSA has been involved.

I'd contest that this "tripartite system" - three players, not two - was the root cause of the regulatory lapses behind Northern Rock. By leaving the Bank in charge of "financial stability", but denying it detailed knowledge about individual banks, Brown left the Old Lady "flying blind".

While the Treasury denies this, last week's move to create a new "financial stability committee", an adjunct to the Bank of England's court, is an admission of the tripartite regime's failure.

Chancellor Alistair Darling says the new committee will bring "valuable external assistance to bear on the Bank's decision-making". But if the bulk of its supervisory staff hadn't decamped from the City, and been hived off to the FSA, that wouldn't be necessary.

And while there will always be a tension between needing to act tough and needing to rescue a bank so as to prevent wider systemic meltdown, it is far better if that inevitably heated debate is held between just two institutions.

By involving a third - with its own set of egos, bureaucratic hierarchies and spin doctors - the scope for dithering, buck-passing and flare-ups is so much greater - as shown not only by Northern Rock, but also recent spats over senior positions at both the Bank and the FSA.

When it comes to running what is arguably the world's most sophisticated banking system, nothing is more important than authority. By pushing the Bank around, imposing financially illiterate Whitehall placemen and then refusing to remove them, ministers have badly dented the UK's regulatory regime.

And now, with ministers refusing to admit the tripartite system was wrong, we remain in the ludicrous position where, when it comes to the power of the new stability committee, the Treasury says one thing and the Bank says another.

After months of in-fighting, our post-Northern Rock regulatory regime remains a mess. The supervision of our banking system is being held together with a blob of political fudge. Meanwhile, billions of pounds of sub-prime liabilities are swirling around, the inter-bank market is still fused, and the integrity of our banking system remains very much at risk.

Yet all ministers - and the Prime Minister - can think about is spinning themselves away from blame. The UK boasts some of the world's finest financial minds. We invented many of the cardinal principles of modern banking. Has it really come to this?

This regulatory bust-up isn't only a disaster in itself. It also comes at the worst possible time. For ministers have insisted on lording it over the Bank just when we need Mervyn King's men to look as strong as possible.

Last week we learnt that annual CPI inflation hit 3.3 per cent in May - way above the 2 per cent target. The old RPIX measure - which the Bank targeted until Brown moved the goalposts four years ago - surged to 4.4 per cent.

While oil prices averaged $75 a barrel last year, the 2008 average - so far - is $108. So crude costs, and the related rise in wholesale gas and electricity prices, suggest there is much more inflation to come.

Tomorrow's newspapers will be full of triumphant noises from this weekend's Saudi oil summit. But almost all Saudi's spare capacity consists of "heavy" oil - which can't easily be refined in Asia's fast-growing markets. Only a lot more "sweet" crude will temper prices - and the Saudis can't help with that.

And it's wrong to say current price pressures stem entirely from expensive fuel imports. Service sector inflation, for instance, has risen from 3.1 per cent in February to 3.8 per cent in May. Soaring producer prices - up 8 per cent - point to serious supply-chain inflation. And wage pressures are rising too - as shown by the Shell workers' recent inflation-busting pay deal.

Given all this, it is absolutely vital that the Bank of England is granted - and is seen to be granted - the ultimate authority to fight inflation. Ministerial calls for rate cuts, and semi-whispered comments about King, must cease. If the Bank raises rates, the Government needs to grin and bear it.

We are now in a serious situation. The political games need to stop.