Shock therapy that feels a little like panic

There are two schools of central banking. The first is the gradualist, in which every rate change is signalled to the markets. The second is the surprise school, which relishes shock treatment.

America's Federal Reserve chairman, Alan Greenspan, is clearly in the first - using his pronouncements to prepare the ground for change, as with the two most recent rises in the federal funds rate.

The Bank of England's monetary policy committee appears to be of the second school. Judging by some of the public comments of MPC members DeAnne Julius and Sushil Wadhwani, who recently in the Financial Times was urging that growth be given a chance, the monetary policy committee appears to delight in delivering a shock.

In fact there does seem to be an air of panic about what the Bank has done. It is only two months since the MPC gave Britain the lowest rates in 30 years when it cut the official rate to 5%. Eight weeks later it is saying it made a mistake.

What the MPC - or those leading the debate on the committee - have partly bought into is the hysteria that has been building up in certain sections of the industry and the media of a housing boom, rampaging gazumping leading to an unsustainable consumer boom. There was some evidence that consumption is running away and the warning was needed.

Maybe. But there is as much bluster about the housing "boom" as there is reality - as the mortgage lenders would testify. True, prices are expected to rise by 8-9% this year, as the Halifax and Nationwide are predicting. But these increases and the way in which they are distributed is as much about supply bottlenecks as it is about excess demand.

Moreover, the idea that the market is exhibiting late-1980s boom conditions is a canard. During the late 1980s some two million-plus properties a year were changing hands. In the last couple of years, after a long economic upswing, 1.2m in 1998 and perhaps 1.4m homes in 1999 will be transferred.

In purely economic terms this is not surprising. Real incomes are rising and the ratio of gross salaries to size of mortgage has been increasing. Equally important is that there has been some fundamental mispricing. The yield on residential properties has been far higher than on other forms of savings. This has encouraged a new generation of rentiers but actually represents a market adjustment, and has nothing to do with bubbles.

The downside risks of the MPC's decision - in terms of the overall prospects for the economy - seem much stronger than those of robust demand in one sector of the market. The recovery in the manufacturing sector, which creates wealth and jobs, still appears to be relatively fragile, although the data may be an underestimate of stock building.

It was not surprising, however, that the British Chambers of Commerce, representing smaller businesses and the best hope of future prosperity, was the loudest complainant at the Bank's decision, with some justification. The sharp rise in sterling against the euro and the dollar following the rate rise announcement, and the anticipation that there could be more to come, will have firms running on the spot as they seek to trim costs to remain price-competitive.

In some respects, adding to exporters' difficulties now is very bad timing. Preliminary estimates for world output growth this year and next produced by the IMF suggest that the emerging market economies, from South Korea to Brazil, are recovering strongly - largely through export growth.

Although this has possible inflationary consequences for commodity prices, it also means that British export markets in the Pacific - hurt by the Asian crisis and falling by more than 50% in some cases - might again represent an opportunity. But it will be not much of one if the same goods can be bought elsewhere, including the European Union and Japan, which have relatively weak currencies.

The MPC also appears to take the rather defensive view that there are tight conditions in the labour market. Yet overall, British unemployment rates - while remarkably low compared to much of Euroland - are still not approaching those in the United States.

The Federal Reserve has long used economic expansion to conduct a fascinating experiment in lowering the non-accelerating inflation rate of unemployment - and taking advantage of productivity gains has assisted in nudging it down. With British unemployment at 6% of the workforce, that is not a challenge the MPC is yet ready to face.

Despite its eclectic mix of members it still appears somewhat hooked on the inflationary past, rather than accepting that there have been fundamental adjustments in earnings and price behaviour. Such technicalities may seem remote from the everyday world of mortgage and savings rates. But they are not. If the bias in the MPC's decision-making leans too far towards caution it is costly to us all.

It is interesting to note that even the intensely conservative European central bank believes that Euroland can hold its main short-term or repo rate at 2.5% for now, making those offers of euro-denominated mortgages seem attractive.

In Britain, the Halifax - which has the largest historic share of the domestic home loan market, will have done itself no favours by being the first out of the box with a 0.14% rise in the standard variable rate for mortgages to 6.99%. This seems unlikely to assist chief executive James Crosby in achieving his goals for a 10% new market share, having gained 7% in the first six months of the year.

The gap in the standard rate between the Nationwide building society and quoted mortgage lenders is 0.5 of a percentage point, making the mutual case rather eloquently. The one group which should benefit is savers. As rates began falling in August 1998, the main mortgage players took the opportunity to cut returns to savers to improve their margins - smart business, but hard on investors. It would be nice to think that as rates move up, the margin will be restored to savers' advantage.

But one suspects it will not.