Bank of England Gets Rate-Setting Powers

LONDON — Rookie Prime Minister Tony Blair marked his 44th birthday Tuesday, but on the first full working day of his new Labor government it was Britain’s business community that celebrated most.

In what Blair called “the biggest decision in economic policymaking” in half a century, the Bank of England was given the right to set interest rates independently for the first time in its 303-year history.

The radical reform, which was accompanied by an expected interest rate increase of a quarter percentage point, moves the venerable bank closer in character to the U.S. Federal Reserve and the independent central banks of Britain’s European partners.

New finance minister Gordon Brown called the rate hike a “corrective action” to ensure that Britain stays within its inflation goal of 2.5% for the coming year.

The raise means higher adjustable-rate mortgages in a nation of homeowners, but financial markets were bullish even as banks moved quickly to raise their lending rates. The pound strengthened and the London Stock Exchange reached new highs, with favorable reaction to the bank reform clearly outweighing reaction to the rate hike, which normally would be bad for stock prices.

“This is very good news indeed for the markets,” said Gavin Davies, chief executive here for the investment bank Goldman, Sachs & Co. A spokesman for the Confederation of British Industries called the action “refreshing. We are very pleased.”

Historically, British governments have set interest rates in consultation with the Bank of England--and sometimes against its advice, for political reasons. The irony of greater free-market orthodoxy being imposed by a Labor Party with deep socialist roots was not lost on the markets.

“It’s incredibly bold and a welcome step,” John Shepperd, chief economist at Yamaichi International, told Reuters.

Analysts saw the surprise decision as an expression of Labor’s confidence and authority in quickly redeeming an election promise. It pleased markets by dispelling any lingering doubts about Blair’s commitment to the smooth and high-rolling economic system that he inherited from the Conservatives.

“We must remove the suspicion that short-term party political considerations are influencing the setting of interest rates,” Brown said.

In the future, inflation targets will continue to be established by the government, but it will be up to a nine-member commission at the bank to adjust interest rates to meet them.

Inflation targeting is also the responsibility of the central bank in countries such as Germany, whose Bundesbank is independent. Fully autonomous central banks free to act without political interference are a key requirement for full European economic integration under the 1991 Maastricht Treaty.

“Our record on inflation and interest rates over recent years is poor, while other countries with independent central banks have performed better,” Brown said Tuesday after meeting with Bank of England Gov. Eddie George.

“I will not shrink from the tough decisions needed to deliver stability for long-term growth,” said Brown, who became chancellor of the exchequer Friday when Blair began naming his Cabinet. Monday was a holiday, so Tuesday marked the country’s first full business day under a Labor Party returning to power after 18 years.

Analysts pointed to the internal reform of the bank as an example of what Blair has called the “radical centralism” of a party he has hauled from the ideological left into the political mainstream.

Under Blair, whose party won in a landslide last week, Labor’s campaign manifesto pledged to reform the Bank of England “to ensure that decision-making on monetary policy is more effective, open, accountable and free from short-term political manipulation.”

A party spokesman said Blair “sees the decision as a very important signal that we ran for office as new Labor and we govern as new Labor.”

In recent months, the Bank of England had been urging a modest rate increase to stop inflation creep. But Kenneth Clarke, who was finance minister of the Conservative government unseated by Blair, repeatedly demurred as the election neared.

On Tuesday, Clarke criticized Labor’s decision to ease the government’s traditionally short rein on the bank as an abdication of responsibility. Clarke predicted that Brown will regret the decision.

“It won’t be good enough for him to turn ‘round and say, ‘It’s not my responsibility, Guv, anymore; I have handed control to this committee, and you must go and complain to them if they get it wrong,’ ” said Clarke.

In the debris of the Conservative Party, handed its worst election shellacking in nearly a century, Clarke is among the survivors emerging to mount a challenge for control. John Major, who led Britain for seven years as prime minister, wants to abandon his party leader post quickly, setting the stage for what is expected to become a bitter succession battle.

In addition to Clarke, former Social Security Minister Peter Lilley, right-wing Euroskeptic John Redwood and former Home Secretary Michael Howard have already declared. William Hague, the 36-year-old minister for Wales under Major, is expected to enter the race today.

With most news breaking on the economic front Tuesday, Blair himself spent his birthday away from the camera’s eye, working at his new prime ministerial office at 10 Downing St. He is scheduled to return to the limelight today with an address to his party’s 419 members in the 659-seat Parliament, which will convene next week.

On Thursday, he will hold his first meeting as prime minister with a foreign leader, receiving Irish Prime Minister John Bruton to discuss the moribund peace talks in divided Northern Ireland.