THE spirit of the German Bundesbank, the shrine of sound money, lives on in Threadneedle Street. Despite growing signs that the economy is slowing down, the Bank of England has raised interest rates by 0.25% to 7.5%. The move surprised the City, dismayed the business community, and will probably lead to a rise in mortgage rates, despite the initial diffidence of the main lenders. It also arrested the recent decline in sterling, as it was surely intended to do, and may result in a harder landing for the economy than had previously been envisaged. The manufacturing sector is already in recession and now seems unlikely to be granted early relief from an exchange rate that makes it increasingly uncompetitive in export markets.

The Old Lady of Threadneedle Street is concerned about the rapid growth in average earnings, clocked at nearly 5% on the same day last month that the Bank issued a mildly optimistic quarterly inflation report. Clearly the monetary policy committee was taken aback by this news which came too late to influence the tone of the report. The situation is especially threatening in the private sector. But on past experience the figure was boosted by unusually high bonus payments, mainly in the financial sector. Fear that the pound would fall from grace and stoke up the engines of inflation was the other major concern at the Bank. This has been a constant theme of the hawks on the committee who have been arguing for a rise in rates since the start of this year. But if average earnings and the exchange rate are to take over from gross domestic product as the main determinants of monetary policy the

implications for economic growth could be grim, not least because of the strait-jacket the Chancellor of the Exchequer has knitted for public spending.

The Governor of the Bank, Eddie George, has been fighting a rearguard action to avert a rise in rates and on at least two occasions has had to use his casting vote on the monetary committee. The betting is that John Vickers, who joined the committee this month as chief economist of the Bank, has turned out to be a hawk, leaving the governor in a minority. If the economy slows to a snail's pace in the next year to 18 months, or even worse moves into recession, Gordon Brown may find himself carrying the can. The Treasury welcomed yesterday's rate hike because it is concerned about earnings growth. But the Chancellor was the man who gave the Bank independence: he is also the one whose Budget tax increases forced the headline inflation rate, crucial in pay bargaining, up to 4%. The omens are not good for the Labour Party, struggling to hold its own in the first elections for a Scottish Parliament

in less than a year.