David Prosser's Outlook: ITV's premium-rate bet on Grade pays off

So Michael Grade seems to be working his magic once more, receiving almost universal praise yesterday for his early efforts at ITV since jumping ship from the Beeb at the end of last year. Mr Grade - lured by the challenge of reversing ITV's slide, plus a handsome benefits package - was entitled to crow about first-half results, mostly ahead of analysts' expectations, even if he had to pour oil on the troubled waters of the premium-rate phone scandal.

Not surprisingly, the first questions many people wanted to ask Mr Grade yesterday were on that controversy. An independent review of the extent to which viewers were misled, carried out by the audit firm Deloitte, will publish its conclusions in October, but it's clear ITV has already taken a major hit, with revenues from premium-rate lines down by £21m in the first half.

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• Advertising boost for Grade's mission to resuscitate ITV

As a business that is hugely dependent on the advertising cycle, ITV needs every penny it can get from other sources, so this threat to its attempts to diversify is one that must not be ignored. Still, it's important to separate the effect on the business of this scandal from the outcry over the fact that viewers were cheated.

In the context of ITV's total sales of £1bn, premium-rate revenue in the first half £33m is of relatively modest importance. Moreover, there is a difference between premium-rate competitions such as GMTV's now notorious phone-in quizzes - or the offerings on ITV Play, suspended since March - and voting on programmes such as Dancing on Ice or Britain's Got Talent.

The latter, ITV suspects, will continue to be much less adversely affected by the premium-rate row. In the first half, this interactive revenue fell 5 per cent, compared to a 65 per cent drop in competitions sales.

As long as ITV can continue to come up with formats that people want to watch - and, just as importantly, vote on - it should be able to at least partially offset losses on competitions, where it will take much longer to restore viewers' confidence.

That said, Mr Grade said yesterday that ITV was now examining whether Play was the best possible use of its digital spectrum. Reading between the lines, it seems pretty clear the channel is unlikely to come back any time soon - and probably never.

Away from this controversy, Mr Grade's fans will seize on ITV's forecast of a 1 per cent increase in advertising revenue during the third quarter of the year. If the estimate proves accurate, this will be the first time for more than two and a half years that the company posts a positive number.

September's Rugby World Cup should be a major help, given that ITV has exclusive rights to the tournament. This was a deal secured before Mr Grade's arrival, but it's clear he sees sport as a major battleground. On football, securing the rights to FA Cup and England games earlier this year was a major coup directly attributable to the new executive chairman.

So what are the clouds on the horizon? Well, one is that sport is a pretty simple operation compared to drama, where Mr Grade believes ITV faces its biggest challenge. Next year's fixtures are a known prospect - unlike the high-quality drama ITV claims will restore its fortunes.

The company also faces a major challenge persuading the Office of Fair Trading to reconsider the contracts rights renewal rules, which prevent it raising advertising rates without a corresponding increase in ratings. ITV argues the market has changed out of all recognition since the OFT set the rules five years ago to prevent it dominating the market. The regulator has yet to be convinced it should even begin a review.

Equally, the advertising recovery recorded by ITV so far - notwithstanding its forecast of a small increase in quarter three - has so far been a story of slowing decline. The same has been true of ratings.

As for Mr Grade's vision of ITV's future strategic direction, that too remains unclear. He will set out his plans in detail after a strategic review in September, and sceptics will suspend judgement until then.

Finally, investors in ITV need to remember that Sky is required to sit on its 18 per cent stake in the company until a Competition Commission inquiry into its possible market dominance is completed. That stake will continue to keep ITV shares subdued.

Even so, it would be churlish to deny Mr Grade his dues. The premium-rate furore has been damaging and it may seem a long time since ITV staff applauded his arrival on day one in the job. But on most measures their messiah seems to be delivering.

A sixth rate rise should be the last

Yesterday's quarterly Bank of England inflation report suggests one of the curiosities of the UK economy over the past 18 months or so is finally beginning to resolve itself. Until now, it has not been immediately obvious why the five base rate increases implemented since last summer have not had a more major effect on consumer spending. Add in the fact that many economists believe the most common measures of inflation underplay the real rate at which prices are rising - excluding as they do fast-rising costs such as council tax bills - and the mystery deepens.

In an environment of disposable incomes squeezed by higher interest costs and a cost of living that may actually be rising more quickly than official measures show, it seems odd that consumer spending has generally been so resilient.

Yesterday, however, the Bank said it was seeing the first indications that consumers have begun to rein in spending. It remains cautious - a further base rate cut is still likely to be necessary before Christmas - but the signs are there. Retail sales growth, for example, was below its 20-year average during the second quarter.

The answer to the first part of the consumer conundrum is that interest rate rises take some time to feed into higher mortgage costs for borrowers who have arranged fixed-rate home loans.

Since these have accounted for a very significant proportion of the mortgage market over the past three years, many borrowers simply haven't yet been affected by the five base rate increases, particularly since the cost of unsecured debt moves much less predictably following Bank of England rate changes.

However, increasing numbers of fixed-rate deals are now coming to maturity, forcing borrowers to switch onto higher variable rates, or at least new fixed rates that are priced to reflect the rising interest rate environment. This helps to explain why the Bank is only now able to see consumer spending moderating.

As for the second half of the mystery, here too the Bank is getting closer to squaring the circle. It's likely that the glut of cheap imports from countries such as China in recent years has offset both the price rises of goods and services that are in the inflation baskets - and those that are not.

Sadly for consumers, that glut is coming to an end. Clothes retailers, for example, expect prices to begin increasing again this year, after five to 10 years of falls mostly down to the cheap imports available from China.

The biggest single contributor to inflation right now is the rising cost of food. Here too, China is having an effect. Rising incomes there have increased the demand for food imports, raising costs on a global basis. Add in the effect of last month's floods back home, and the domestic outlook too is for higher food prices.

The question for Monetary Policy Committee members is the extent to which the higher cost of food - a necessity, after all - will reduce consumer demand for other goods and services. There's good reason to think that now the previous rate rises are finally beginning to have an impact, consumers will no longer be able to accept higher prices across the board. That's one reason why the Bank is hoping only one more interest rate rise is necessary this year.

d.prosser@independent.co.uk