COMMENT; Testing time as economy hits capacity buffers

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The Independent Online
The horns of the base rate dilemma are moving further apart. This week's clutch of economic statistics has shown both higher-than-expected inflation and lower-than-expected growth. The time is fast approaching when Kenneth Clarke will have to make up his mind whether he cares more about controlling inflation or about preventing growth from slowing in the run-up to the general election. Whatever the doubts about the quality of the official figures, it is clear that the pace of growth has slowed significantly since the end of last year. The picture that is emerging from the statistics is one of an economy starting to bump into the capacity buffers. Manufacturers are not able to increase production as fast as they were and are starting to push through price increases.

That these capacity constraints have been reached so swiftly in the economic cycle is cause for considerable alarm; manufacturing output is still lower than its 1990 peak and only just over 10 per cent higher than its 1979 peak. The fact that this situation has coincided with a weak exchange rate should set all the inflation alarm bells ringing doubly loud. The last time the exchange rate suffered badly - in the autumn of 1992, when the pound dropped out of the exchange rate mechanism - the inflationary effect was benign since industry was still deep in recession and capacity was in plentiful supply. This year the combination of events is far more malign; the fall in sterling began when the economy was still expanding at full tilt.

The Bank of England's view is that this is clear cause for a rise in interest rates. The other view, held by a number of senior Treasury economists, is that a weak exchange rate is even now little reason for concern since competition between manufacturers and retailers is so much more intense than it has been. Consumers are also much more aware of value for money than they were, the argument goes, and as a consequence, a good deal more demanding. Never mind the fact that deflationary pressure of this sort always has a comparatively short shelf life, the Treasury view gave Mr Clarke a rationale he needed for following his heart. He turned down Mr George's advice in May and, presumably, in the two subsequent meetings. The Chancellor has put more weight on the clear evidence of slower growth, and opted not to raise base rates.

However, he will not be able to ignore actual increases in inflation, as opposed to worrying exchange rate moves that might presage higher inflation. This week's statistics showing that the rate of increase in core prices charged by manufacturers reached a four-year high last month was bad news. Tomorrow's retail price figures will be analysed minutely to see whether the pressure has shifted further along the pipeline. Anecdotal evidence seems to suggest it has. Consumers can still get a great bargain on cars and clothes but price-cutting in other areas - such as supermarket foods and newspapers - is coming to an end. If Mr Clarke and Mr George are opting for different horns of that policy dilemma, their monthly meetings could get very interesting indeed.

Fisons suffers a possibly fatal blow

Yesterday's rise in the Fisons share price was a somewhat curious response to the breakdown of merger negotiations with drugs rivals Medeva, given the strategic problem it now faces. Fisons' chief executive, Stuart Wallis, has invested a great deal of time and effort in attempting to consummate a marriage. The investment in credibility has been even greater.

A "for sale" sign has been hanging outside the Ipswich-based company since the sudden demise in 1992 of John Kerridge, architect of the group's rapid growth in the 1980s. Despite being hawked around every drugs group in the Western world, there were no takers for Fisons. A merger with Medeva, itself now something of a fallen stock market star, looked like a last desperate attempt to salvage something from the wreckage. Now that option has been blocked off, it is not clear where the company can go from here.

To be fair, Mr Wallis has done a decent job in restoring Fisons' standing in the City since his arrival in September. He overturned received wisdom in the pharmaceuticals world and sold off the company's research and development activities, along with a raft of more peripheral businesses, to wipe out debt and build up a cash mountain which could be worth close to pounds 500m by the end of the process. Apart from the cash, Mr Wallis is left with little else - essentially two rather tired-looking anti-asthma drugs, Intal and Tilade, and the marketing operations. Intal is rapidly moving off-patent and, although Tilade's protection should run into the next century, there is virtually nothing in the pipeline to follow up with.

Mr Wallis's strategy of trying to buy drugs that fill the pipe has suffered a possibly fatal knock in the failure to woo Medeva, the only large UK group to have succeeded in pursuing such a course. If talks with other potential sellers fail to bear fruit, shareholders are likely to become impatient. Perhaps the best course would be for the company to be run for cash, like a self-liquidating investment trust. Such a policy should appeal to the chairman, Paddy Linaker, given his demands for high payouts by companies when he was managing director of M&G.

Not the last word on Leeson

Here are three reasons why the Bank of England report on the Barings debacle, expected to be published next week, is going to fall short of an adequate expose of the affair.

The first is that, however independent the investigative team, however objective its findings, it will be hard for the Bank to be completely impartial about an affair that exposed faults in its own procedures and system of supervision.

Although the report will have some critical observations to make on this front, that may only harden the perception that the Bank's position is a good deal more embarrassing than is being admitted.

A second is that investigators have failed to win any co-operation from the authorities in Singapore, which are undertaking their own investigation. Singapore was where the losses were clocked up, so a vital source of information and insight is excluded.

Most important of all, however, the Bank was unable to gain access to the main culprit, Nick "I was framed" Leeson, presently languishing in a Frankfurt jail. However suspect Mr Leeson's account of events, it at least needs listening to. In an attempt to pre-empt the report, his wife Lisa is holding a press conference in London today. Most of it will no doubt be of the "my life of misery since Nick was jailed" variety but she is also likely to repeat some of the trader's more colourful allegations. Among these was that the top brass in London would have been highly relieved if he had disappeared for good.

It is one thing to be accused of a massive failure of control, as the Bank's report will, but quite another to be accused of complicity. This report is highly unlikely to be the last word on the affair.