It will be an older and wiser group of central bankers that gathers this week at the Bank of England to set interest rates. If August was the month in which the Old Lady of Threadneedle Street stood aloof from the turmoil in the markets, then September was when she was dragged headfirst into the crisis. Mervyn King, the Governor, and Sir John Gieve, his deputy with responsibility for financial stability, now bear the scars of the first bank run for 140 years, a colossal U-turn on bank bailouts, a Commons savaging from MPs and a Treasury on the warpath for someone to blame.

Setting interest rates will seem like small beer by comparison. Nonetheless, this will be an unusually important meeting. Here is our regular round-up of the issues that the Bank’s Monetary Policy Committee (MPC) must weigh up.

Financial markets: fearful
The great unknown is whether the liquidity problems and unexpected losses from securities linked to US sub-prime lending will worsen in the months ahead. The ripple effects from the market’s ructions will be felt first in the financial services industry and then elsewhere. But assessing how extensive the damage will be is very hard.

The Bank’s new credit conditions survey last week showed that the supply of credit to companies was expected to deteriorate further. That will add to expectations that the market is making borrowing more costly of its own accord, leaving the Bank some leeway for lower rates.

Costs and prices: no pressure
If the MPC wants to cut rates, it is helpful that inflation is being well-behaved: it dropped to 1.8 per cent on the consumer price index in August, below the Bank’s 2 per cent target. Earnings growth is similarly restrained at 3.5 per cent.

Yet the benign global disinflationary conditions of the late 1990s and in the first half of this decade have faded. As a result, it is harder than it once was for central banks to cut rates and boost confidence when crises hit. A clear sign of the dangers comes from the growth of the money supply: M4, or broad money, rose by 13.5 per cent in the year to August.

Growth and output: healthy
Mortgage lenders are raising their rates. Meanwhile, the Royal Institution of Chartered Surveyors has reported that house prices are falling at their fastest pace in two years – so while growth in retail sales volumes of 4.9 per cent in the year to August indicates surprisingly robust consumer activity, the MPC may wonder whether it can last.

Still, growth certainly is strong enough to justify interest rates that, at 5.75 per cent, are hardly penal. The Office for National Statistics said that GDP grew by 3.1 per cent in the year to the second quarter, well above its trend. Its index of services rose by a very strong 1 per cent in the three months to July.

The international economy
Two developments of the past month stand out here: the Federal Reserve’s bold half-point cut in official rates and the easing in market interest rates in the United States and the eurozone. US employment dropped for the first time in four years and the housing market there continues to worsen.

Rate verdict: no change
The rapid response shown by the Fed this week is not the MPC’s style. Nor are rate cuts as urgently needed as in the US, where growth is much lower. So while the data point to a moderate easing in policy, there is enough uncertainty around for the MPC to sit it out this month.

Mood music

The credit squeeze and the problems at Northern Rock have dominated the public statements of members of the Monetary Policy Committee this week, leaving much unsaid about the prospects for interest rates.

Mervyn King, the Bank’s Governor, made a spirited defence of his handling of the crisis at the Commons Treasury Committee. He added that “a cut in interest rates at the first sign of a problem is not the way to go”.

Andrew Sentance, the panel’s most hawkish member, said of the problems: “I think the economy is still relatively strong. There is some nervousness coming in from the consumer side of the economy . . . Interest rates will have a further impact on consumer spending.”

Paul Tucker, another hawk, said: “The underlying problems [in financial markets] have started to be addressed. Investors have started to distinguish between companies that have problems and those that don’t. It’s gradually under way.”

Kate Barker said: “The housing market remains relatively robust.”

David Blanchflower, the most doveish panel member, declined to comment on interest rates at all when making a speech on labour markets last week.

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