The Bank of England’s inflation report brought grim news about the economy. And it was almost as bad for the Bank itself.

If the outlook for the economy is so dire, what on earth was the Bank’s Monetary Policy Committee thinking of just two weeks ago when interest rates were still 4.5 per cent? The answer is that the Bank was still worrying about inflation when almost everyone else was terrified that the economy was about to plunge off a cliff.

Last week’s cut in rates to 3 per cent, and yesterday’s commitment from the Governor of the Bank, Mervyn King, to take them down to “whatever level is necessary”, is welcome evidence that the Bank has finally caught up.

But confidence in Mr King, who chairs and dominates the committee that sets interest rates, has taken another bad knock. Confidence in the entire system for controlling interest rates has also suffered.

The decision in 1997 to give the Bank sole power to set rates was seen as a masterstroke by Gordon Brown. For ten years it seemed to work pretty well, though the Bank was criticised by some for not taking action to curb the inflationary threat posed by booming house prices.

But this year has proved the first big test. The questions put to the Bank were very tough. How do you balance the threat from an extraordinary commodity price bubble – including the soaring oil price – against what has turned out to be the most severe instability in the global banking system since the outbreak of the First World War? It was a very difficult test. But the Bank’s exam results were still disappointing.

Although one member of the Bank policy committee gave warning months ago that the economy was heading for recession, Mr King insists that the events of the past few months could not have been predicted.

Setting policy is easy with the benefit of hindsight, he said yesterday. It is true that, particularly since the collapse of Lehman Brothers on September 15, the economy has deteriorated very rapidly.

Mr King pointed out rather testily to journalists that the media was not calling for huge rate cuts a couple of months ago. But that is hardly the point.

Other central banks have reacted sooner and more decisively, notably the US Federal Reserve, which slashed rates to 1 per cent last month.

Although it could be argued that this was because the US economic downturn was more advanced, Mr King’s critics say it reflects the Fed’s better understanding of the seriousness of the credit crunch and its greater willingness to take bold action.

The concern about Mr King’s record on interest rates would be less serious if it was a one-off. But he has appeared behind events throughout the credit crisis and has been forced into a number of embarrassing U-turns.

These stemmed partly from Mr King’s focus on “moral hazard”, the concern that bailing out banks would encourage reckless behaviour in the future. This made him very reluctant to help banks as they struggled to cope with the effects of the frozen credit markets. He relented eventually, but he had to be pushed every step of the way. His attitude may have reflected his lack of contacts with the City, which some claim he viewed with suspicion (a view of course now shared more widely).

Mr King has only just started his second five-year term and is essentially immovable. So his critics can only hope that he will learn from his mistakes. There was little sign of it yesterday. He did not go quite as far as Norman Lamont’s famous “Je ne regrette rien”. But he came close.

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