Jeremy Warner's Outlook: Fed struggles to maintain 'measured' response

Howard's economy - East Coast mainline - Lara Croft meets...
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The Independent Online

Nobody Would have been surprised by the Fed's decision last night to raise interest rates by a quarter point, the seventh consecutive such increase. Rather more surprising was the still relaxed view the Federal Reserve's Open Markets Committee takes of the outlook. Despite mounting inflationary pressures, the Fed largely stuck to its pre-existing script in repeating that policy accommodation can be removed at a pace that is likely to be measured.

Nobody Would have been surprised by the Fed's decision last night to raise interest rates by a quarter point, the seventh consecutive such increase. Rather more surprising was the still relaxed view the Federal Reserve's Open Markets Committee takes of the outlook. Despite mounting inflationary pressures, the Fed largely stuck to its pre-existing script in repeating that policy accommodation can be removed at a pace that is likely to be measured.

At the previous meeting, some Fed members had argued that this wording should be dropped so as to give policymakers more flexibility in acting if circumstances demanded it. There has been growing concern that the Fed's relatively relaxed view of the US inflation outlook is causing similar complacency in financial markets, helping to keep long bond rates artificially low. Alan Greenspan, the Fed's chairman, has called the persistence of extraordinarily low long-term interest rates a "conundrum", yet there is no mystery here.

Real short-term rates have only just begun to turn positive after a prolonged period when they were lower than inflation. In the search for yield, deposits have therefore been chasing longer dated money. Whether at the Fed's planned "measured pace" or not, this phase in policy - an aberration, really - is drawing to a close. The outlook for bonds looks increasingly rocky.

Howard's economy

Clever boy. Gordon Brown's Budget seems to have done the trick, to judge from the latest Guardian/ICM poll, in upsetting the Michael Howard bandwagon, which has looked so strong in recent weeks that it's even been possible to believe the Tories were in with a chance. The ICM poll once again seems to dash Conservative Party hopes, though with more than six weeks left to the expected election day of 5 May, there's plenty of time for the wheel of fortune to turn again.

Eight points, on the other hand, is one hell of a lead. Opinion polls are notoriously unreliable, and it may be that this particular one is just a freak. Earlier polls, showing the gap narrowing to as little as 2 percentage points in one case, may be more representative. Nonetheless, it is tempting to surmise that the Budget did actually make a difference, particularly among the over 65s, who were promised a £200 council-tax rebate and free bus passes.

Yesterday it was Michael Howard's turn to strut his stuff on the economy. There were few surprises in a platform that can be broadly summarised as cut taxes, cut borrowing, cut the civil service and stuff the euro. The Conservative Party leader plans to save approximately £12bn by axing the New Deal, abolishing a whole swathe of quangos and making 250,000 bureaucrats redundant. However, only £4bn of this saving will immediately be earmarked for tax cuts, with the rest going towards a reduction in public borrowing. Whether this "my prudence is bigger than your prudence" approach to the public finances will win votes remains to be seen, but somehow it seems rather unlikely.

By the time the Conservatives have met promises to halve council tax bills for pensioners, there won't be much left for anything else. A better, though undoubtedly less prudent policy, might have been to promise much deeper tax cuts, for the belief that Labour will raise taxes again after the election remains Mr Howard's strongest card by far.

It's hard to see how there are any votes at all in promising to make the Office for National Statistics fully independent, or indeed in the creation of a Fiscal Projections Committee to audit the Budget projections, commendable though both these initiatives would be. Rightly or wrongly, the suspicion remains that the statistics are routinely manipulated to meet the incumbent Government's political purposes. But it is only those who are inclined to vote Tory anyway for whom such an arcane initiative would be a clincher. Even the pledge never to join the single currency no longer has the resonance it once plainly did. It's hard to believe that this is the issue on which the Tories managed so painfully to tear themselves apart. Few people bother to think about it at all these days. The pound is generally regarded as safe in the Chancellor's hands.

Unfortunately for Mr Howard, the same goes for the economy, where the Chancellor's constant parading of the longest period of uninterrupted economic growth since the early 18th century is a pretty formidable record to counter, never mind that more than one-third of it was under the previous Tory government, or that the foundations for today's prosperity were laid well before Mr Brown was given the keys to No 11 Downing Street. Whether Mr Howard's proposals for the economy are credible scarcely seems relevant. They are unlikely to make much headway against a Government which cannot yet be reasonably accused of mishandling the economy.

East Coast mainline

It doesn't take a genius in rail economics to work out that GNER's Chris Garnett will have to pull out all the stops to make his £1.3bn bid for the East Coast mainline franchise pay off. His boss at Sea Containers, James Sherwood, is not the forgiving sort.

An £80m subsidy in 1996, the year that GNER first won the flagship London-Edinburgh route, has turned into a premium payment which will average £130m a year over the next decade.

Had GNER under-bid and lost the franchise, it would have ended Mr Sherwood's little UK rail odyssey which began all those years ago when the Conservatives were still clinging to power and desperately throwing money at bidders in order to get the rail industry off their hands. The purse strings have since been tightened, and today it is passengers, as opposed to taxpayers, who will have to bear the true cost of providing train services. The budget airlines have made sure GNER is in an intensely competitive market on long-haul journeys and despite rising petrol prices, the car will always appeal more than the train to many. So GNER's scope for jacking up fares is limited.

The obvious soft underbelly is GNER's staffing levels, which look generous compared with other inter-city operators. Bob Crow at the RMT is already making blood-curdling noises about what he will do if GNER decides to make the premium payments at his members' expense. Luckily, there is a safety net tucked away in the fine print of the franchise agreement announced yesterday. If, after four years, GNER is not hitting its revenue targets, then the taxpayer will pick up 80 per cent of the shortfall. If passenger numbers do come through as planned - and GNER's numbers are based on a one-third increase in traffic over the next 10 years - then Mr Garnett gets his bonus. True, the East Coast line will no longer be quite the licence to print money it has been for the past nine years, but it should still be a decent little earner, while Mr Sherwood is protected on the downside.

Lara Croft meets...

The prospect of a two-way shoot-out for Eidos is the best news shareholders in the beleaguered computer games company famous for Lara Croft have had in years. Andy Brough, the Schroders fund manager who speaks for 20 per cent of Eidos's shares, is right to be suspicious of the all-cash bid from Elevation Partners, which on the face of it looks like a cosy stitch up between management and US-based private equity. There's no guarantee of jobs or equity participation for management from Elevation, but whatever the outcome on this front it looks a feeble price for this one-time glamour stock to be selling out at. SCI is a smaller company, but its recent management record is more impressive and its offer is all in shares, giving downtrodden Eidos investors a continuing stake in what should be a much strengthened business. Feminist icon or cyber bimbo? Whatever Bono, one of Elevation's partners, might think about Lara Croft, there's little doubt about Jane Cavanagh, the woman who runs SCI. She's a smart cookie and deserves to win.

jeremy.warner@independent.co.uk

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