The credit crunch has now been joined by an inflation crisis. Exuberance in the banking sector caused an excess of cheap money, a systematic mispricing of risk and, in the past nine months, a sudden clampdown on lending. At the same time, climbing energy and commodity prices have been stoking inflation. The combination looks set to make for an ugly 18 months for British households: a squeeze on the cost and availability of borrowing and a surge in the cost of living. Britain may yet escape a recession, but the decade of easy economics is over.

While prices are spiralling higher, business and consumer confidence is souring. Consumer spending is faltering, businesses are shelving investment plans, jobs are being cut. Public sector unions are already trying to renegotiate pay deals, an effort that a ministerial pay freeze is unlikely to halt (see page 1). Policymakers are faced with the parallel dangers of inflation and economic stagnation, so-called stagflation. Much of the pain is because of events outside the control of any one central banker or minister. The booming Asian economies, which are pushing up prices for so many raw materials and foodstuffs, is one. There is barely a countrynot suffering from accelerating prices. Mervyn King, the Governor of the Bank of England, and Alistair Darling, the Chancellor, were both eager to emphasise the global nature of the problem.

But the agony is partly self-inflicted. The plunging value of sterling, partly a reflection of foreign concerns about the stewardship of the British economy, has lifted import prices. The decision by the Bank years ago to turn a blind eye to ballooning credit supplies and mushrooming inflation in assets, notably house prices, has not helped either.

The Bank's philosophy is that it is too late to do anything about inflation over the next 12 months. That battle has been lost. Prices will continue to rise faster than the 3 per cent limit for some time. Slamming the brakes on sufficiently to bring inflation immediately back within target would produce “unnecessary volatility in output and employment” - in other words, it might trigger a recession.

This is as close as the Bank has ever come to acknowledging that growth and jobs, as well as inflation, play a part in its decision making. It was careful to emphasise that it remained vigilant about higher prices in the shops feeding through into higher wage claims, but the impression yesterday was that the Bank was displaying dovish tendencies. City traders are now pricing in just one quarter-point increase in base rate this year to 5.25 per cent; beforehand they were expecting two quarter-point rises to 5.5 per cent.

This is a risky approach for the Bank to take. It would be too harsh to accuse it of defeatism in taming short-term inflation. It has always worked to a longer-term time horizon, setting interest rates to achieve 2 per cent inflation in two years' time. It is logical to regard inflation disappointments over the next few months as milk already spilt. Yet the Bank has to be seen as ruthlessly tough on inflation.

Benign global conditions have made taming inflation a relatively simple task over the past decade. That is no longer the case. It is now that the Bank faces a real test. It is now that members of the Monetary Policy Committee have to steel themselves to make difficult decisions and if necessary ignore intense populist pressure.

Ministers in turn need to leave the Bank alone to make the necessary decisions. Borrowing £2.7 billion last month in order to fund a tax cut is worrying evidence that this Government is willing to put political considerations before prudence. The prize of continuing low inflation is too precious for that.