Jeremy Warner's Outlook: BA's Rod Eddington plans Iberian swansong

Pensions chalice - Stock market rally
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The Independent Online

With one bound, British Airways has jumped free of its partner on the kangaroo route, Qantas. Its heart is set instead on a Spanish donkey called Iberia. Rod Eddington, BA's chief executive, may hail from Down Under too, but there is no room for sentimentality in the airline business and he will net a nice fat £425m from the sale of BA's 18.25 per cent shareholding in the Aussie flag carrier.

With one bound, British Airways has jumped free of its partner on the kangaroo route, Qantas. Its heart is set instead on a Spanish donkey called Iberia. Rod Eddington, BA's chief executive, may hail from Down Under too, but there is no room for sentimentality in the airline business and he will net a nice fat £425m from the sale of BA's 18.25 per cent shareholding in the Aussie flag carrier.

There was a time when BA regarded equity stakes as the cement which held together partnerships with other carriers. Not so any longer. These days global alliances deliver all the benefits airlines need without the hassle, cost and risk of them having to own chunks of one another. Hence, BA and Qantas will continue to carve up the profitable London-Sydney route between them by pooling services and revenues even though the glue of cross-shareholdings has gone.

BA says the Qantas cash will be used to pay down debt, which still stands at a junk-rated £3.8bn, and strengthen the balance sheet. For what? Why, to merge with Spain's Iberia, of course. Here's where BA stands the logic of not owning equity in other airlines on its head. The truth is it was never going to merge with an airline 8,000 miles away in another hemisphere, so why bother to hold any shares in Qantas at all?

Iberia is another matter. The economies of scale to be wrought from merging two European airlines are much more appetising. Add to that Iberia's similar management philosophy and complementary route network and, who knows, it could even be a marriage made in heaven. Yet shareholders will have to wait a while for the honeymoon to commence. BA and Iberia cannot consummate the marriage before the US and Europe have agreed an open skies deal, this for the simple reason that under present bilateral arrangements BA Iberia would be neither a British or a Spanish flag carrier, allowing America to deny landing rights to both of them.

Natural optimists like BA's chief executive believe a deal can be done between Washington and Brussels next year, allowing him to eject from the pilot's seat with Iberia safely on board. The tortured history of bilateral air service negotiations suggests that may be wishful thinking. In the meantime, BA shareholders should bear in mind that since debt reduction is now top of the airline's priorities, any chance of it rejoining the dividend list is disappearing fast over the horizon.

Pensions chalice

So Alan Johnson is to inherit Andrew Smith's job as Work and Pensions Secretary. Let's hope he's up to it, for he's got one of the biggest challenges in government lying in wait for him. It's a little unfair to lay the blame for the crisis in occupational pensions entirely at the Government's door. By removing the tax credit on dividends to spend the money elsewhere, the Government exaggerated the size of pension fund deficits, but it didn't cause them to arise in the first place. That was the result of mismanagement and excessively optimistic assumptions about the costs of funding future liabilities. Had the Government carried on paying the tax credit, as likely as not companies would only have used it as excuse to extend the contribution holidays that many of them took in the 1990s.

The Government's fault lies rather in failing to recognise the enormity of the crisis that has been creeping up on us. Ministers have been guilty of sweeping the problem under the carpet. They pride themselves on their ability to make "difficult choices", but they have singularly ducked them when it comes to pensions. Ministers have just fiddled while Rome burns. By greatly expanding the public sector without reforming the pension rights of civil servants, they have hugely inflated the public sector's unfunded pension costs and made it into a substantial burden on future generations of taxpayers.

The means tested benefit system has also been greatly expanded, destroying the incentive to save for retirement. According to projections by the Institute for Fiscal Studies, some 80 per cent of retirees will eventually be on the minimum income guarantee. If this is anywhere near the truth, it would mark an astonishing failure in public policy for a country which boasts one of the wealthiest economies in Europe.

Adair Turner, chairman of the Government-appointed Pensions Commission, promises to publish his interim report on the pensions crisis on 12 October. Significantly, this will restrict itself to an analysis of the state of private pensions provision and the nature of the problem. Policy recommendations won't be published until after the next general election for fear of upsetting the political apple cart. That rather says it all. The Government shows no appetite for the costly and unpopular decisions that have to be made as a matter of urgency if it is to defuse the pensions time bomb. The new broom at the DWP will need to come with bristles of steel if he is to succeed.

Stock market rally

The FTSE 100 has been becalmed in a tight trading range of around 150 points for nearly a year now, which I'm told is one of the longest such periods of low volatility ever. Eagle-eyed followers of these things will have noticed that in recent days the index has come within a whisker of breaking out of the range and, encouragingly, it's on the upside too. Last night the index closed just 16.6 points off its trading range high of 4,575, last achieved in late April. To a chartist, that strange breed of analyst whose business it is to predict future movements of the market from the lines shown on a chart, this would be an incredibly bullish sign, proof positive of a strong rally in the index right up to Christmas and beyond.

I've never put much store by chartism myself, but accept that if enough people believe in it, then it is more than likely to come true. How sustained the rally proves is another matter, and though I remain a long-term bull on equities, I see no reason to believe we are yet unambiguously in the long march back to former peaks. The FTSE 100's surge these past three weeks ­ achieved on incredibly thin volumes ­ was little more than the "office boys' rally" traditional for the late summer period. It remains to be seen what happens now that the big cheeses are back from their hols.

The truth is that the fundamentals still look less than reassuring. Corporate profits have recovered nicely, but the global economic recovery seems to be stalling. There is still at least one more interest rate increase to come in both Britain and the US, but it is equally plain that the peak of the interest rate cycle will be much shallower than previously thought. As our Monday columnist, Stephen King of HSBC, pointed out, US Treasury yields are again approaching historic lows, suggesting a very high degree of scepticism about the economic outlook.

The high oil price is only part of the explanation. The other is fear of what might happen the other side of the US presidential election. The US economy hasn't yet experienced the demand correction the textbooks say should follow a prolonged boom, or should occur to deal with a current account deficit as yawning as that of the US. Bush or Kerry, it doesn't really matter, whoever is returned in November will need to address the burgeoning budget deficit as a matter of urgency.

The problem of a stalled recovery is compounded in Britain by some structural problems in equity markets peculiar to these shores. Corporate profits are likely to remain under pressure in Britain because of the need to refinance underfunded occupational pension schemes. At the same time, many of these funds are maturing, which causes them to reduce their equity weightings. A big traditional buyer of British equities has become one of their biggest sellers. This is a bigger problem in Britain than elsewhere, because up until now Britain has had a much larger, funded final salary pensions sector than either the US or Europe.

None of this looks like the sort of backdrop for a sustained rally.