When Chancellor of the Exchequer Gordon Brown handed control of interest rates to the Bank of England in 1997, his stated aim was to free decisions on rates from politics. A little more than two years later, the experiment looks like a mixed success at best. The bank's monetary policy committee pushed up rates to 7.5% in June, 1998, then ratcheted them down to 5% a year later. In its latest twist, the BOE surprised the markets by raising rates a quarter point on Sept. 8 just months after Britain dodged a recession. Britain's newly free central bank needs to settle down. It should also do some serious research about how far along Britain has evolved into a New Economy and what that means for monetary policy.

The BOE says it is taking early action to head off inflation. The bank is worried by predictions that growth could soar to 3% to 3.5% in the second half of this year and over 4% next. But the bank risks killing business confidence and putting further upward pressure on the pound, whose high level is already hurting exporters.

Over the last two decades Britain has been through a brutal restructuring. There are signs that the pain is finally beginning to pay off. Britain's unemployment is down to 4.4%--its lowest in decades. Even with tight labor markets, overall inflation remains low--just 2.2%. It appears that Britain may be enjoying some of the same New Economy effects that have persuaded Federal Reserve Board Chairman Alan Greenspan to tolerate strong growth in the U.S.

But the novices at the BOE lack Greenspan's sophistication and restraint. What spooked them this time was a report that house prices rose at a 9.4% rate over the last 12 months--the biggest surge in a decade. Rising house prices have been associated with boom and bust cycles in the past. But basing monetary policy on rising asset prices may be a mistake. Britain now has a globally competitive service economy. Most companies can't raise prices. The BOE should reexamine the changing economic fundamentals of its monetary policy.

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