Jeremy Warner's Outlook: Bank's ability to cut rates limited by oil price, even though it is also dampening growth

Misys fuels its crisis in credibility; Lack of brass in AgCert's muck
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The Independent Online

Unfortunately for him, it is the CPI that the Government has asked policy to be judged by, and it edged up again last month to 2.4 per cent. Since the figures were collected we've had Hurricane Katrina and another 5p a litre on the cost of petrol. It is therefore virtually certain that the inflation rate for this month will be above 2.5 per cent. Who knows where it heads from there.

What is clear is that the inflation rate is turning out to be higher and the growth rate lower than the Bank of England was forecasting in its last Inflation Report. The Chancellor must be regretting his decision to switch the inflation target from RPIX to the CPI. At the time this looked the politically expedient thing to do, as RPIX contained some measure of house price inflation and was therefore rising strongly. The CPI, by contrast, contained no such ingredient and was falling. The switch may have allowed interest rates to be lower than otherwise.

Today the tables are reversed. With house price inflation slowing fast, RPIX is abating too, despite the climb in oil prices. The CPI, on the other hand, is climbing with the oil price. Policy is as a consequence more in the sway of rising fuel prices than it might have been, making a cut in interest rates to deal with lower growth harder to justify.

Admittedly, so far there appears to have been little in the way of what economists call "second round effects" from the rising inflation rate, either in the form of higher wage claims or in the cost base more generally. That will encourage the Bank of England to believe that inflation is still essentially under control, and will fall back again once we are through the present, presumably short-term, spike in fuel prices.

Yet if workers cannot claim the inflating cost of fuel back in higher earnings, then they will cut back on spending elsewhere, further dampening economic growth. The Bank targets inflation not as it is now, but as it thinks it will be two years hence, so in theory what's happening now is only relevant to the extent that it changes the Bank's view of the future.

All the same, it would be difficult psychologically for the Bank to justify cutting rates at a time when the inflation rate has strayed so far above target, especially if it thinks the oil price spike temporary with decent levels of growth likely to resume next year. To cut or not to cut in response to Katrina? It's almost as tough a call here as it is in the United States.

Longer-term trends in inflation are equally confusing. More so than perhaps any other developed economy, Britain has a two-speed inflation rate. The cost of goods has in general been deflating for more than 10 years now. In some cases, particularly in electrical goods, the fall in prices has been dramatic. The cost of a PC, for instance, has more than halved, and you get an infinitely better product for your money than you did back then too.

Yet the cost of services continues to inflate strongly. Since 1996, service costs have risen by more than 40 per cent, against a decline in nominal terms in the price of goods of nearly 3 per cent. Put another way, we've needed to spend increasingly less of our income on goods, leaving more to be spent on housing and services.

If the deflationary effect in goods were to come to an end, then the old paradigm would be broken and interest rates might have to be higher to control general price inflation. This is not altogether impossible. The deflationary effect on import prices of a strengthening pound is now presumably fully spent. Asian industrial development promises a continued flood of ever cheaper goods from the Far East, but even here there must be a limit to how low prices can go.

As an increasingly irrelevant producer of goods, but a rather successful purveyor of services, Britain has had a decade of rising living standards and superior economic growth. With productivity growth now stalled, thanks possibly to rising levels of public spending, this benign set of circumstances has rarely looked more threatened. The Bank's task becomes ever more challenging.

Misys fuels its crisis in credibility

No wonder Misys, the software company, abandoned a controversial bonus package for two of its senior executives last week. Directors must have known that there was a nasty profits warning to announce to already fractious investors. Continuing with the bonus plan would have added insult to injury.

As it happens, one of the plan's supposed beneficiaries would almost certainly never have earned his bonus anyway, even on the undemanding performance criteria set.

This was Ivan Martin, for it was in his banking division that the problem of delays in recognising revenues and increased investment in product development - the two primary causes of the profits warning - occurred.

The main reason for wanting to put the bonus plan in place was to keep Mr Martin and his opposite number in healthcare software, Tom Skelton, from being poached before a new chief executive is decided upon. The present incumbent, Kevin Lomax, plans to give up executive responsibilities by 2008.

The damage to management credibility inflicted by yesterday's profits warning presumably means that Mr Martin is no longer a candidate. With no bonus plan to keep him, it remains to be seen whether the higher achieving Mr Skelton hangs around for long enough to discover whether he's to be the anointed one.

Lack of brass in AgCert's muck

Where there's muck, there's brass, the old saying goes, but AgCert has yet to unearth any of it from the pig farms of South America where it plies its trade. AgCert's big idea was that of capturing and burning methane from the rear end of these animals in a device called a biodigester. The resulting reduction in greenhouse gas emissions would then be turned into carbon credits which could in turn be sold to European nations desperate to meet their obligations under the Kyoto Protocol on global warming.

That at least was the story told to investors in the London market when AgCert floated in June. Yesterday, the brown stuff hit the fan after AgCert admitted that the sales targets it placed such faith in only three months ago are pie in the sky. The chief executive is paying with his job.

One day, trading of such carbon credits may become big business, but for now the whole idea of selling credits into Europe generated elsewhere in the world just doesn't seem to be working.

There are, it seems, two problems for AgCert. First, the pig farms in question are in remote locations, causing big logistical problems for the installation of the biodigesters. Second, the emissions made by the pigs have to be certified by the farm, then the relevant national government and then by a United Nations body in Austria so they can be traded.

This is proving a bureaucratic nightmare which so far has prevented the certification of a single credit from elsewhere in the world for trading within the European system. The problem will presumably be cured eventually. Indeed it must be, for European industry will be left deep in the manure if it cannot buy its carbon credits from outside the union. Within Europe, there simply aren't enough to go around.

j.warner@independent.co.uk

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