For Bank of England, read Bank of the City, without any regional input
In this context it is worth looking at the September monthly economic survey submitted by the Bank's 12 regional agents. These surveys are more qualitative than quantitative, being informed by the local agent's personal judgment and experience, but they are useful nonetheless.
Far from the economy overheating, the overall picture is that the consumer-led boom is off the boil. Consumption growth slowed further over the summer, particularly spending on consumer services. House price inflation also eased - something I can confirm from talking to housebuilders in Scotland. This general slowing is on the back of rising interest rates since last year.
However, there is a silver lining in the company sector, where firms have maintained healthy investment activity, which is helping to offset any deceleration in consumer activity. The agents report that investment intentions remain strong, although slightly below the record levels seen in mid-2007.
Other data confirms that business investment was up by a healthy 7.8 per cent year-on-year in the second quarter of 2007. What appears to be happening is that businesses are responding to upbeat exports sales and strong profits to add necessary capacity. Could capital spending keep the economy growing even though consumer spending is in retreat? The Bank seems to be hinting at this: its August inflation report forecast business investment rising faster than overall GDP growth over the next two years.
However, I remain worried that the turmoil in the financial sector - which is, after all, a crisis of confidence - will seep through to the business investment sector as well as consumer spending.
The recent credit crunch has made it more costly for businesses to raise funds for capital expenditure. Read deeper into the Bank of England's regional agents' report and you will find this caveat: "There were a few reports that some investment decisions were being reviewed or deferred given the rising cost of finance and tighter credit conditions."
Here is the problem: consumer spending is always slow to fall because we all try to defend our standard of living, even in troubled times. Business investment behaves altogether differently. Businesses are prone to sudden, collective shifts in investment spending, particularly if they fear economic uncertainty. That can shut down capital spending in a trice.
The US Federal Reserve has just cut interest rates by a half percentage point in a bid to restore confidence and keep credit flowing. Coupled with the ultra-cheap dollar, that should help the US manufacturing export sector offset the American housing meltdown. Should the Bank of England follow suit? Or should it go on worrying about inflation and keep interest rates high?
My next worry is that the Bank of England may not listen to the negative straws in the wind regarding investment decisions that are coming from its regional agents. This is in stark contrast to the US Federal Reserve which has a more sophisticated way of taking the economic temperature of the different parts of the US than our own over-centralised Bank of England. For "over-centralised" read City of London-biased.
The Federal Reserve is just that - a series of regional central banks that co-ordinate policy. Interest rates are set by the Federal open market committee (FOMC) which is made up of seven national governors plus the presidents of the 12 regional Federal Reserve banks (though only five vote at any one time).
The FOMC is the equivalent of the Bank of England monetary policy committee (MPC). The decision to set a particular interest rate is taken by majority vote, as with the MPC. However, while the MPC is composed of Bank executives plus four disembodied "experts" appointed by the Chancellor, the FOMC always reflects the local economic needs of its constituent regional banks.
But consider what happens in the UK. The recent (erroneous) decision by Mervyn King, the Governor of the Bank of England, to hold off pumping liquidity into the jammed money markets was based on his conception of "moral hazard". King and the Bank live in the bubble that is the City of London. His first thought was to police the City financial institutions as if they were the totality of the economy. A run on a Newcastle bank was of secondary concern.
Because of its regional focus, the US Fed produces detailed local economic statistics - they don't just rely on the "feel" of local agents, as does the Bank of England. There are regional inflation figures for industrial areas such as Chicago, and for local house price movements. In the UK, on the other hand, regional trends are subordinated to the need of the Bank of England to manage the City. The fact that UK interest rates are nearly always higher than in the US or eurozone has precious little to do with supposed rampant inflation in Glasgow or Cardiff.
The last rise in rates (to 5.75 per cent) was predicated on inflation that was largely a London and south of England phenomenon. It has been apparent that house prices have been moderating in much of the UK since the start of the year.
Here is my suggestion: in the wake of King's woeful performance, the MPC needs to be reformed. It should follow the Federal Reserve model and have representatives of the 12 UK regions sitting on the MPC as of right, though only a minority would vote at any on time.
Regionalising the committee would give it a better understanding of economic conditions across the UK and let it set interest rates to suit inflation as it is being experienced, not the unique conditions of London.