Jeremy Warner's Outlook: Higher inflation means paradoxically the $2 pound may be here for a while longer yet

ABN consortium bid hits immovable object; EMI suspends dividend payments
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The Independent Online

There's long been a simple rule of thumb about currency markets which has held good throughout my adult life - whenever the pound gets to $2, you sell sterling and buy the greenback. As the pound reaches its highest level in 26 years, is this rule going to be confounded, or is this just another of those once-in-a-decade selling opportunities?

The main factor putting a rocket under the pound right now is the prospect of higher interest rates. This was yet further strengthened yesterday by data showing the growth in average earnings surged to 4.6 per cent in the three months to February, which is above the "comfort" point of 4.5 per cent the Bank of England uses to assess whether rising prices are generating second-round inflationary effects.

An astonishing 1 percentage point of this increase is attributable to bumper City bonuses, so it could be argued that underlying wage inflation is still not too bad.

But even accepting that this growth in earnings is concentrated among a relatively few number of people, it's still real money, and it is one of the major factors behind rising house prices and growing capacity constraints in the wider economy. The fact that the bonus pool is shared between probably no more than 300,000 to 400,000 people may make no difference to the effect it has on price inflation.

The irony is that if City bonuses help cause higher interest rates, this small elite of high earners will be the least affected. Rather, it will be the indebted lower-paid who are disproportionately hit. The higher interest rates go, the more appealing the UK becomes to foreign money. We already have one of the highest interest rates in the developed world. By the time the present cycle tops out, it may be the highest of the lot, making Britain a target for interest-rate arbitrage with countries that have a low cost of money.

Right now, bank rate at 5.25 per cent is the same as the US. But whereas our rates are heading higher, the next move in US interest rates is likely to be down. The case for a quarter-point rise in UK interest rates next month is now unarguable.

The question the City has to ask itself is whether the Bank might want to go for the full-half point. Inflation has so far failed to respond to the therapy of occasional quarter-point rises. Time, perhaps, for more radical action. Certainly only a short, sharp shock looks capable of bringing the still-booming housing market to heel.

News that the consumer prices index has moved more than 1 percentage point above target, prompting an official letter of explanation from the Governor of the Bank of England, gives the Monetary Policy Committee the perfect excuse. It's looking as if the Bank will have to raise interest rates to 5.75 per cent eventually, so it might as well deliver the dose in one go. Indeed, the MPC may feel it needs to for the purpose of restoring battered credibility alone.

All this suggests that the pound may stay high for some period of time, rather in the way it did in the early 1980s. By reducing import prices, a high pound helps reduce inflationary pressures and thereby interest rates too. But it may take some time and until the current inflationary outburst is flushed from the system, mortgage holders are going to feel the squeeze. The Governor warned of more difficult times ahead some while back. It looks as if he may be right.

As for the pound, the idea that it has found a permanent footing at $2 and above is just fanciful. Circumstances none the less look as if they are conspiring to keep it there for a little while yet.

ABN consortium bid hits immovable object

When in doubt, do nowt. Or that seems to be the position adopted by the Dutch central bank governor, Nout Wellink, over the proposed consortium bid for ABN Amro. He's deeply suspicious, and the clear implication of his statement yesterday is that, unless the consortium can satisfy his concerns, the whole thing is a non-starter. Mr Wellink's comments were brushed aside by the consortium as largely routine - the sort of thing regulators are bound to say in circumstances like these. This I doubt. Central bankers choose their words carefully, and to have published a statement in these terms suggests that Mr Wellink is very unhappy indeed about the turn of events. No banking takeover can proceed without the approval of prudential regulators. The Dutch central bank already seems to be putting its foot down.

To state, as Mr Wellink does, that "from a prudential point of view, an offer by a consortium would constitute a strong risk-increasing and complicating factor, both in the preparation of the transaction and in its execution and implementation" is pretty close to saying no. Mr Wellink says that any concrete proposal will be assessed with meticulous care to ensure consortium members have adequately addressed these risks.

The statement to some extent vindicates the "carefully, carefully" approach adopted by Barclays, which in its negotiations with ABN has bent over backwards to answer Dutch sensitivities to any merger. The merged banks' head office will be in Holland and the lead regulator will be Mr Wellink. The chairman too will be Dutch. Barclays took the view that it had to make these concessions even so much as to get past first base.

By attempting to gatecrash these cosy arrangements, the consortium - Royal Bank of Scotland, Banco Santander and Fortis - tries to make the case that it is shareholder value, not central bankers and national pride, which should determine the outcome.

Let the market decide? I'm not sure prudential regulators, particularly in continental Europe, have psychologically accepted that point yet when it comes to banking, part of the lifeblood of any national economy. Regulators are in any case absolutely right to be concerned on prudential grounds about break-up bids for large banks. Any such exercise is bound to be immensely complex with clear risks to confidence. Royal Bank of Scotland's Sir Fred Goodwin would do much better to bid by himself than mess around with the ultimately doomed endeavour of a consortium bid.

EMI suspends dividend payments

Hoorah! To the relief of all, EMI has axed its dividend, sending the shares soaring. It was indeed a perverse reaction to the suspension of dividend payments, but then it has long been apparent that EMI can't afford such payouts. What's more, things finally seem to be on the mend, with operating profits better than expected and the cost-cutting programme ahead of schedule.

On the other hand, EMI is by no means out of the woods yet, and the suspicion is that plans to securitise the back catalogue are more about the company's need for cash than unlocking value for shareholders. Securitising the business is tantamount to mortgaging the company's most attractive asset, and so may act as a deterrent to potential bidders.

The humbling of the music majors is one of the most striking examples there is of the transforming powers of the internet. EMI and its rivals have been forced painfully to come to terms with the music download phenomenon, but the damage is far from over. The once-fat, monopolistic, margins enjoyed by this industry are a thing of the past. Music companies are in essence no more than distributors. The internet has disintermediated them.

Yet rather than embracing this new medium, the industry has fought the Web every inch of the way, a strategy for which it is now paying a terrible price. On top of these structural issues, which are industry-wide, EMI has suffered a hits famine. Can Eric Nicoli, the chief executive, halt the decline? It's anyone's guess, but, in seven years of trying, he hasn't managed it yet.

j.warner@independent.co.uk

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