Inflation panic grips Fleet Street

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It really is fascinating to watch how the Bank of England's breach of what is, after all, a fairly arbitrary inflation target, suddenly has previously sanguine economic forecasters throughout the press shrieking for immediate action.

In fact, one of the biggest advocates of the "it's different this time" theory, Times commentator Anatole Kaletsky, this morning calls for a half-point hike in interest rates next month to show that the Bank is serious about controlling inflation.This is from the man who continually berates and belittles the European Central Bank for keeping on raising interest rates, decrying the ECB's rather stern line on money supply as old-fashioned.

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It's no surprise Mr Kaletsky is calling for tougher action - low or apparently non-existent inflation forms the basis of his "low rates forever" economic utopia. If inflation isn't dead after all, then the Bank needs to take control right now before the pillars of debt propping up his dreams of a new era are kicked away.

Trouble is, it's already too late...

So why is Anatole Kaletsky calling for a half-point interest rate rise next month? His arguments are sound enough.

He points out that some people would argue that the $2 pound should ease inflationary pressures in the economy, meaning the Bank can tread carefully on interest rates. But as he argues, the strength of the pound (remember, sterling was challenging the $2 mark just at the end of last year, so this isn't a short-lived spike) should already have curbed inflation. The fact that it hasn't "suggests that underlying inflationary pressures are much stronger than the Bank of England and the markets expect."

Eventually, the spectre of soaring inflation would make sterling less, not more, attractive. This could lead to a sharp fall in the pound, thereby sending inflationary pressures even higher.

Much of this depends on whether the markets believe that Mervyn King and his colleagues on the Monetary Policy Committee really have any control over the UK economy. So Mr Kaletsky says that the Bank really needs to hike fast now, to safeguard its credibility.

It's nice to see he's finally caught up with reality - but the trouble is, it's too late now. The time for half-point hikes was long ago - a half-point before Christmas, or in summer last year, for example, might have helped offset some of the pressure we're seeing now. But the truth is, the Bank sealed the fate of the UK economy when it made that terribly timed, highly divisive decision to cut the base rate by a quarter point way back in August 2005, just as annual house price growth was on the verge of flattening.

That was the moment at which the Bank lost its credibility. Governor Mervyn King was outvoted, showing he didn't have a handle on the rest of the MPC. Meanwhile, the markets, the population and anyone else who was watching realised that the real nature of the MPC was not to control inflation, but to avoid a recession like the plague. Just like its counterpart in the US, the British central bank had no intentions of spoiling the economic party; just like the Fed, the whole idea was "no recession under my watch."

Eddie George, the former BoE governor, has already admitted that when he slashed rates to historic lows near the turn of the century, he was desperately trying to avoid a recession. He's acknowledged that rates couldn't possibly have stayed that low long term; but that this was a problem for his successors to deal with.

What no one seems to understand - or want to understand - is that the wider economy is not too different to running your household finances. If you spend more than you earn for a prolonged period of time, enjoying the good life while your household balance sheet hollows itself out (a period we shall call, for talk's sake, a boom'); then at some point in the future, you have to rebuild that balance sheet - start taking sandwiches to work, holiday in Sidcup rather than Sydney, take the kids out of Eton and send them to the local sink school (this period we shall describe as the bust').

The more profligate you were during the boom, the more thrifty you have to be during the bust - and clearly, the more painful the transition to a lower standard of living.

Here in the UK, we're sitting on consumer debt of around £1.3 trillion. That's some boom. And now we're heading for the bust to match.

Just before we go, another argument in Mr Kaletsky's piece is that the euro's strength is more important to the strength of sterling than UK rates. If, he says, the ECB keeps hiking rates and the US economy keeps weakening (which he finds unlikely, but we believe is pretty much inevitable), then the euro will probably keep rising, and sterling with it - which could mean we see the pound hit levels as high as the $2.20 to $2.50 "that it occupied for most of the 1970s and early 1980s."

We couldn't help but be reminded of something he wrote only back in December, when the pound was challenging the $2 mark again. At that point, he argued blithely that the dollar was now the buying opportunity of the century or at least the next 25 years.

In fact, we quote: "if [sterling] falls below $1.95, it has nowhere to go but down if the pound tests the $2 barrier and then falters, it will be time to take a flutter, if not mortgage your house." (You can read the original piece here: Demise of the dollar is greatly exaggerated.)

Sterling fell as low as below $1.93 in mid-January, and again at the start of March. Were hoping that no one literally staked the roof over their heads on a strong dollar.

Turning to the stock markets

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The FTSE 100 ended Friday 46 points higher, at 6,486, with support coming from miners and M&A targets such as Alliance Boots and Standard & Chartered. Mining stocks Xstrata, Lonmin and Vedanta Resources all benefited from the rising copper price. For a full market report, see: London market close.

Elsewhere in Europe, the Paris CAC-40 ended the day 109 points higher, at 5,938. In Frankfurt, the DAX-30 was 99 points higher, at 7,342.

On Wall Street, the Dow Jones ended the day at a fresh record closing high of 12,961, having added 153 points as the likes of Caterpillar reported expectation-beating results. The tech-heavy Nasdaq climbed 21 points, closing at 2,526, and the broader S&P 500 ended the day 13 points higher, at 1,484.

The Nikkei closed flat today at 17,455 - an increase of just 2 points - having fallen back from an earlier high of 17,656.

Crude oil had fallen back to $63.75 this morning, whilst Brent spot was 12c lower at $66.21.

Spot gold was little changed from its price in New York late on Friday, last trading at $691.90. Silver, meanwhile, was last quoted at $13.88/oz.

And in what is set to be the world's biggest-ever financial services takeover, Barclays agreed to buy Dutch bank ABN Amro Holding NV for 67bn euro today. However, ABN Amro may still receive a rival bid from Royal Bank of Scotland, Santander and Fortis, with whom it is meeting up today. Barclay's shares had risen by as much as 1.5% in London already today, whilst ABN Amro's were up 2.4% in Amsterdam.

And our two recommended articles for today...

What has the independent Bank of England given the UK?

- Ten years ago this May, the current Labour administration swept to power and announced operational independence for the Bank of England. Since then, the Bank has built up a reputation for inflation-busting. But one $2 pound and one explanatory letter to the Chancellor later, maybe it's time to reconsider. For Adrian Ash's analysis of what the Bank has done for Britain - and what it's likely to do next, click here: What has the independent Bank of England given the UK?

Why tourists are holidaying in hospitals

- With the growing popularity of medical tourism, a new generation of travellers is as likely to return home with a new hip as a tacky souvenir. In this MoneyWeek article, just available to non-subscribers, we pick three of the sector's fittest firms: Why tourists are holidaying in hospitals