A battle the rate cutters must eventually win

Rates; Wharf bound; British Airways
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The Independent Online

Bad news. Interest rates cut again. Only kidding, but there's a serious point. It is easily forgotten that savers outnumber borrowers by a fair old margin, and for them, lower interest rates are by no means a welcome development. In point of fact, rates are quite unlikely to be reduced at the end of the Monetary Policy Committee's two day meeting today. Three of the committee's nine members voted against a cut at the last meeting and, given that the bizarrely mixed performance of the UK economy hasn't changed very much since, their view will presumably hold sway this time around.

But you never know. That same bizarre mix – strong in some areas but deep in recession in others – makes for some unpredictable decisions, and the case for further cuts is certainly not hard to argue. Business confidence is at rock bottom, manufacturers are shedding jobs right, left and centre, and even spendthrift consumers are beginning to worry about recession. It is also worth remembering that UK short-term interest rates remain stubbornly higher than both Euroland and the US, this despite the fact that our inflation rate is quite a lot lower.

The differential – three-quarters of a point for Europe and one-and-a-half percentage points for the US – is easily explained. Historically, Britain has been prone to repeated bouts of inflation, which makes our policy makers more conscious of inflationary risk than others. Nor, with average earnings once more rising at a rate not justified by economic growth and improved productivity, is it yet clear that Britain's inflationary disease has been fully cured. All the same, the case for maintaining higher rates than the Continent becomes harder to sustain by the month, and it may be possible for UK interest rates to drop to European levels without serious inflationary consequences.

The point has been made many times before, but it bears repeating. We are dealing with a very different type of business downturn this time around. Recessions are usually triggered by central bankers jacking up interest rates to address an excess of demand, which in turn is causing prices to rise. What we see today is precisely the reverse. After a sustained period of over investment, there is an excess not of demand but of capacity, which in turn is prompting sharp cutbacks in business. The central bank response is a mirror image as well. Interest rates are being reduced in an effort to stimulate demand and revive business confidence.

Unfortunately, the medicine is proving slow to act. While consumers continue to party on, sustained by a cocktail of low prices and low interest rates, business is refusing to respond to therapy. The end game is hard to predict, and the now serious divisions on the Monetary Policy Committee on how best to respond are indicative of just how acute the policy dilemma really is. On one side of the fence lies a continued consumer boom, on the other a now serious business downturn. Today's call is among the most difficult the MPC is ever likely to make.

On a practical level, too, the MPC is faced with new challenges. Predicting how lenders will respond to policy, and what real effect it might therefore have on the economy, is becoming ever harder. Abbey National yesterday said that if there was another cut in rates over the months ahead, it would not be passing on its full effect either to savers or borrowers. Mortgage rates won't be cut by as much, nor will deposit rates. This was billed as a move to help savers, which is a bit rich, since Abbey and others responded to the last base rate cut by cutting deposit rates by even more. Still, it's an interesting move. If others don't follow suit, the company will gain savers but lose borrowers.

For the MPC, such statements none the less give comfort that interest rates can indeed be cut further without necessarily feeding the house price or consumer boom any more than they have already. Mervyn King, the Bank of England's ultra-hawkish deputy governor, may succeed in holding the rate cutters off this time, but he's going to have to give ground eventually.

Wharf bound

The Corporation of London was yesterday putting a brave face on it, but it's hard to see how Barclays' decision to swop its historic headquarters on Lombard Street for an air-conditioned tower block at Canary Wharf can be anything but bad news for the Square Mile. Barclays has spent the best part of the last three years scouring the City for a suitable site, but couldn't find anything that compared with the Wharf in terms of price, space and flexibility. Other major banks, including HSBC and Citigroup, have found the same.

Not that you will find the City admitting to disappointment. After the trench warfare that characterised the City's relationship with Canary Wharf during its first development phase in the 1980s, it's these days meant to be all sweetness and light. The line is that the City's success as a financial centre has to be judged by London as a whole, of which the Wharf is plainly a part.

But can the Corporation really think that? For all its pomp and history, the Corporation is in the end just a local authority, and it relies for its prosperity on the rates it levies on its properties. The present co-existence with Canary Wharf only really works as long as London as a financial centre keeps expanding, and there are enough tenants for both of them. The present recession in wholesale financial services has brought that to a grinding halt. If anything, London as a financial centre must now be contracting.

For hundreds of years, the City has been the original business "cluster", an ever-expanding group of similarly minded enterprises all symbiotically living cheek by jowl in a manner that has made London unrivalled as an international financial centre and the shopping centre of choice for international financiers. Today, nearly all complex financial transactions of any size pass through London in some shape or form.

Canary Wharf is fast on the way to developing the same cluster-like characteristics, and that's got to be a worry for the City, disadvantaged as it is by high rents, planning restrictions, poor infrastructure and aging office space. Barclays has been headquartered on Lombard Street for more than 300 years, and its decision to move is powerfully symbolic of the City's growing irrelevance as a must place to be.

British Airways

Sixteen months into the job at British Airways, Rod Eddington must be starting to wonder whether the same fate awaits him as befell his predecessor. The omens do not look promising. Profits and passenger numbers are down, the house broker is forecasting a loss, jobs are being axed ruthlessly and, in desperation, BA has embarked on another possibly doomed attempt to get regulatory approval for a transatlantic merger with American Airlines. Close your eyes and it could be 1996 all over again with Bob Ayling in the hot seat. But most galling of all, Rod has to put up with the sight of Ryanair's Michael O'Leary soaring into the stratosphere in his trademark trainers, jeans and rugby shirt, as if the airline business was a licence to print money.

j.warner@independent.co.uk

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