Now that demand is no longer running ahead of output, there is a case for a period of stability in UK interest rates

Mervyn King, deputy governor of the Bank of England, has said that, in a fully transparent system, monetary policy decisions should come as no surprise. Ideally they should even be boring. The surprises should come from new data, according to this doctrine, which more and more central bankers are beginning to espouse.

The consensus of outside commentators is that there will be no change in UK base rates announced today. These inferences can be supported by high authority. Eddie George, the governor, in his Mansion House speech last month, detected tentative signs that domestic demand growth was beginning to moderate to offset the fall in sterling. He also said that in his view, which was "broadly shared by most of the other members of the MPC", inflation would remain around the government's 21/2 per cent target over two years. Nevertheless one should keep one's fingers crossed. For the desire to surprise, either by the timing or the amount of a change, is built in to the very walls of central banks, whatever is said in speeches.

The more interesting question is whether UK base rates are, at 6 or 61/4 per cent, near their peak or whether they still have further to rise.

The national income estimates are now available up to the first quarter of this year, together with quite important revisions for earlier years. Until these figures were published it looked as if demand was rising faster than output and that imports were acting as a safety valve against inflationary pressures.

This could have pointed to a diagnosis of suppressed inflation - in other words, the high exchange rate for sterling has deflected home demand towards imports and overseas demand away from British exports.

Even that, however, was not a certainty. For a large current payments deficit may simply be a mirror image of an inflow of overseas investment and may have little to do with domestic inflationary pressure. No one has explained how to differentiate between the two kinds of deficit.

All one can do is to pick up a few clues to see if the overseas inflow represents long-term investment or a temporary inflow of financial funds attracted by relatively high interest rates. On that score Britain seems to be doing well. The very favourable inward investment figures announced yesterday have been distorted by their use by both sides in the holy war now raging over the euro.

In this war, the issue of exchange rate policy has been thoroughly confused with the question of whether or not to join the euro. Inward investors may indeed worry about the volatility and the overvaluation of sterling; but it would certainly be possible to give the exchange rate a more explicit role in policy without Britain signing up for euro membership.

But to come back to domestic inflationary pressures. The latest estimates suggest that final domestic demand is no longer rising faster than output (see chart). The new figures have stimulated David Walton of Goldman Sachs to label June as "not a good month for the hawks on the monetary policy committee". Apart from the national income figures themselves, average earnings growth also declined from a 6 per cent peak earlier in the year to 4.4 per cent - a rate now compatible with the 21/2 per cent inflation target.

Output growth itself is no longer rising faster than productive capacity. The quarter to quarter estimates, for what they are worth, now show growth at about 2 per cent a year, or well within safety limits. The latest survey estimates and house price indices all suggest that domestic demand has moderated.

The indicators to which the hawks can point are not all that impressive. Take for instance the fall in sterling. The entire fall from its earlier peak came before the last meeting of the MPC in June. Moreover, it looks as if the deflationary effects of the earlier steep rise in sterling have not yet come fully through into prices. If this is true, the more recent drop in the pound will have less of an inflationary effect.

Nor is there any very striking other "news". Pessimists will make play with the latest drop in the household savings ratio. But this is offset by the improvement in the financial balances of business corporations.

The hawks' arguments rely very much on forecasts. For instance, if you compare the undershoot in public sector spending, especially public investment, in the last financial year with government projections for 2001-2002 there could be a rise of almost 7 per cent in real terms. Moreover, although earnings increases have declined, there are tentative signs that pay deals have been rising.

But if I were looking for some ammunition to give the hawks, it would not be from these domestic indicators but from the international environment. Demand and output are still gathering pace in the euro-zone; they are decelerating only slightly in the US, and even Japan may be a little more buoyant. Moreover, if the consensus is right that both US and euro-zone interest rates have further to rise, experience would suggest that this would exercise an upward pull over the UK.

Meanwhile, both the MPC and the European Central Bank need to be more explicit about the way the three-fold rise in oil prices since the beginning of 1999 is to be treated. Under the much admired New Zealand monetary regime this would be treated as an exogenous force allowing a once-for-all rise in the price level. The consensus reached after earlier oil price rises was that the immediate impact should be accommodated - that is that governments and central banks should not try to offset them completely by cuts in other prices. On the other hand, they should not be allowed to set off a self-fulfilling spiral of higher price and wage expectations. This will be easier than it was at the time of the 1970s oil price explosion, as oil now represents only about 2 per cent of gross domestic product in most countries. But a Trappist silence on the subject will not promote the public understanding that central banks claim to want.

My own view has long been that we need to pay far more attention to assessing what is actually happening and to intelligence of all kinds than to econometric crystal ball-gazing. Of course one needs also to ask whether there are obvious sources of inflationary or deflationary pressure already visible that have not yet had their effect. Although the inflationary threats seem greater than the deflationary ones, the issue is far too speculative to justify hasty action and a pause is justified until the MPC comes back from its summer holidays. This may displease Mr King if he is still voting with the hawks, but should gratify his desire for a boring monetary policy.