Brown gives Bank independence to set interest rates

The Chancellor, Gordon Brown, set the seal on a frenetic first 100 hours of activity by the Blair government when he stunned the City and Westminster yesterday by handing control of interest rates to an independent Bank of England.

He announced at his first Treasury news conference that he would increase interest rates by 0.25 per cent today but that would be the last time he would have day-to-day control over borrowing costs.

The Chancellor said the rise - which will cost the average mortgage payer around ?16 a month - and his shake-up of monetary policy were designed to defeat inflation and lay the foundations for long-term stability and growth.

From next month, the Government's attempt to take the politics out of interest-rate decisions would mean the Bank would have 'operational control' of monetary policy.

Mr Brown said last night that the objectives of policy were 'high and stable levels of employment and growth', the same as they had been in the 1940s when the Bank was nationalised, but added: 'It is right in the 1990s to deal with them in modern ways.'

Attention will now be focused on the planned July Budget, in which Mr Brown is expected to raise taxes in a bid to diminish the need for the newly independent Bank to raise rates aggressively over the coming months.

Asked about his plans for fiscal policy, the Chancellor said he had no need to raise taxes to fulfil Labour's public spending commitments, but added that he would 'take action against inflation at every point where it is necessary'.

The Chancellor has been advised that inflation, if left unchecked, will be closer to 4 per cent than 3 per cent by the end of next year, well above the Government's 2.5 per cent inflation target. However, he is concerned that over-reliance on interest rates to check inflation would push up the value of the pound and harm exports.

Mr Brown's decision to grant the Bank operational independence was taken on the eve of polling day, talked over with senior Treasury mandarins on Friday, agreed by the Prime Minister, Deputy Prime Minister John Prescott and Foreign Secretary Robin Cook on Sunday evening, and transmitted to the Bank on Monday morning.

Eddie George, the Bank's governor, described the decision to put him at the apex of a nine-strong monetary policy committee as 'a very bold step' which had left him both surprised and pleased that Mr Brown had 'moved as decisively as he has'. Mr George insisted yesterday that there was no conflict between low inflation and growth.

Explaining the move, the Chancellor said: 'This is the time to take the tough decisions we need for the long-term interests and prosperity of the country. I will not shrink from the tough decisions needed to deliver stability for long-term growth.'

The ceding of operational control to the Bank - which can only be rescinded in times of national crisis - was hailed by Tony Blair as 'the biggest decision in economic policy making since the war'. Downing Street called it 'a big, decisive act of leadership', proof that New Labour would govern as it promised.

Sterling, shares and government gilts soared in the wake of the announcement, which was also praised by the Treasury's panel of 'wise people', industrialists and a previous chancellor, Norman Lamont.

However, Mr Brown's predecessor, Kenneth Clarke, was sharply critical. 'What you are going to see, undoubtedly, is tighter monetary policy than you might otherwise have got from a perfectly responsible chancellor of the exchequer who is prepared to take the broadest possible view of what is in the interests of British industry and commerce and the people who work in it,' he said.

The Chancellor, however, stressed that everything he had learned about the economy since arriving in office on Friday emphasised the need to make interest rate policy 'free of political manipulation'.

Legislation will be required in the first Labour Queen's Speech - to be unveiled next Wednesday - to change the Bank's status. The four independent members of the new monetary policy committee will also have to be appointed.

Mr Brown repeatedly stressed at his press conference that it was 'a British decision, taken for British reasons' to create a stable climate for long-term economic growth - and not to prepare for possible entry into a single European currency.

Dream come true, page 3: Leader comment, page 16

Larry Elliott, Will Hutton, page 17 Rate rise 'will curb house boom', and Notebook, page 18

The governor, his deputy and the man most likely to succeed

EDDIE GEORGE: governor of the Bank of England

Respected by the financial markets for his cool head, chain-smoking Mr George has earned the nickname 'steady Eddie' and will be difficult to dislodge. Though frequently worsted by former chancellor Kenneth Clarke over interest rate judgments, his anti-inflationary credentials are impeccable. Gordon Brown was at pains yesterday to stress that the governor will work his full term to the end of June 1998.

Mr George, aged 58, wants to keep his hands on the new power to set interest rates in another five-year term, rather than a few lucrative twilight years in the City. Given his good standing, Mr Brown might decide to give the markets the devil they know. One possible snag is the governor's scepticism over European monetary union.

HOWARD DAVIES: Bank of England deputy governor

The former head of the Confederation of British Industry makes little secret of his ambition for the top job in Threadneedle Street. His quasi-industrial background and enthusiasm for EMU should suit. Unfortunately, his relations with Gordon Brown 's office are cool - perhaps because he is seen by some as a close Blair supporter. The markets might view his political hobnobbing as suspect and his glossy presentation as lightweight. Dealers prefer their central bankers dour.

The Chancellor's plans to create a second deputy governer bode ill for Mr Davies. One deputy will get the relatively glamorous job of monitoring monetary policy, the other will be responsible for the worthy but dull job of banking supervision. Mr Davies might leave if offered the latter.

GAVYN DAVIES: possible new deputy governor or future governor of the Bank of England

The chief economist of City broker Goldman Sachs is politically well-connected. After a glittering academic career, he worked in the Number 10 policy unit for the last Labour government, is on first name terms with the new front bench and gave Neil Kinnock sanctuary at his country home after the 1992 defeat. His wife, Sue Nye, works in Gordon Brown 's office.

He travels light ideologically, preferring the forensic skills of economic modelling to sweeping solutions to economic problems. He knows failure. In 1994 he told the world interest rates had been held - a few hours later they rose.

Mr Davies would have to take a pay cut to return to public service. He recently spent ?3 million on a clifftop home in Devon.