Jeremy Warner's Outlook: Inflation risks remain, but there are powerful reasons for the Bank not to move right now

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The Independent Online

How to read the minutes, published yesterday, for the last meeting of the Bank of England's Monetary Policy Committee, held two weeks ago? Worse-than-expected inflation figures this week appeared to increase the pressure for an early rate rise. The minutes suggest that in the absence of some confidence-sapping meltdown in the Middle East, rates are in fact going to remain on hold for some little while yet.

The unanimity of the Committee in voting for no change is only partly explained by changes in its composition. Stephen Nickell, who used routinely to vote for a rate reduction, has gone. So too, sadly, has David Walton, who at his last two meetings voted for a rise. The dissenters are therefore removed from the equation. Yet the thrust of the argument was powerfully against change too, and with good reason.

As things stand, we are in one of those periods of acute economic uncertainty. To the outside world, everything seems fine. The economy is still growing, inflation, though rising, is nothing yet to frighten the horses, and if the claimant count is rising, so too are levels of employment, the difference being explained by high levels of immigrant labour and greater labour participation.

Yet the US economy seems to be slowing fast, credit spreads are widening, though not yet to crisis proportions, and, of course, energy and commodity prices keep on rising. Judging by the continued boom in the Chinese economy, which grew at 11.3 per cent in the second quarter, these latter pressures don't look like easing any time soon. It must surely only be a matter of time before these pressures work their way through to second-round inflationary effects.

The fact that they haven't already done so continues to be a wonder to all, despite the obvious explanations of imported deflation in the price of goods from the Far East and the growing pool of cheap, immigrant labour. Common sense dictates that, none the less, eventually they must.

The big danger is that this occurs just when the world economy is beginning to slip precipitously in any case, leaving the Bank of England in the invidious position of having to raise interest rates against the backdrop of steadily reducing growth.

Indeed, to raise rates now in an attempt to nip any energy induced inflationary pressures in the bud may precipitate just such an unwanted slowdown. As the Governor of the Bank of England has repeatedly warned, though things look extraordinarily stable from the outside, from the inside they have rarely looked less predictable or more uncertain.

When you are not clear which way things are heading, the best policy is to do nothing at all. Reassuringly, this seems to be the approach adopted by the Bank of England. Absent of some further catastrophe in the Middle East, it seems unlikely things are going to become any clearer in the weeks and months ahead. Eventually, there will be a landing of some sort. Whether it will be hard, soft or somewhere in between is at this stage impossible to say.

Whatever the answer, the British economy may be structurally better placed to react than most. High levels of debt on variable rates of interest make the economy relatively sensitive to monetary action. What's more, rates are already comparatively high when measured against the eurozone and Japan. This means there is more scope for demand stimulus should the need arise.

For the time being, however, there is no particular need to do anything at all. Higher-than-expected inflation is plainly a worry, yet to react to this with a hike in interest rates would be quite wrong. It is inflation two years out that rates are meant to target, not inflation as it is now.

NYSE/Euronext: not yet a done deal

In theory, Euronext, the pan-European stock market group, is still steaming ahead with plans to merge with the New York Stock Exchange. The terms have been announced, the documents signed and it remains only for shareholders and regulators to agree. In practice, this remains far from a done deal.

In France and Germany, there is a considerable political head of steam building for the alternative tie-up of Euronext, owner of the Paris bourse among others, with Deutsche Börse, the Frankfurt stock and futures market.

This "keep the Americans out" endeavour is backed by a major shareholder in both companies, TCI Fund Management, a hedge fund run by the secretive Christopher Hohn. He's already made a huge amount of money riding the revaluation of stock market assets which has occurred this past few years, and, with big positions in both companies, he stands to make a great deal more if he can facilitate a consolidating merger of European exchanges.

The Euronext board reckons the NYSE deal is worth more to its shareholders than anything Deutsche Börse has so far managed to come up with. The fact that Mr Hohn is a big shareholder in both companies gives him a different perspective. In the round, he would be better off with the Deutsche deal.

But the main obstacles facing both potential transactions are regulatory in nature. Euronext users have grave concerns about both tie-ups. The Deutsche Börse proposal first. Here alarm focuses on the vertically integrated nature of the Deutsche Börse business model.

The effect is that it is virtually impossible to buy a share in a German company without using the Deutsche Börse clearing and settlement system. This lack of competition in settlement and clearing may lead to higher transaction costs overall and is certainly quite harmful to anyone trying to set up in competition to Deutsche Börse.

The fear is that this model would be imposed on other European exchanges if Deutsche Börse acquired Euronext. A separate concern is the monopoly of key areas of futures trading that any get-together would entail. This in itself might seem to justify the intervention of London-based competition regulators, even though any such marriage would be a European affair. Euronext owns Liffe, the London futures market.

There are no such competition issues to stand in the way of the New York Stock Exchange, but that hasn't stopped users worrying about the implications for stock trading. The NYSE has structured the deal in a way which in theory allows for the combined company's various stock markets to be subject to local regulation. Yet the holding company will still be domiciled in the US.

How long before the US Securities and Exchange Commission, under pressure from Congress, attempts to impose its own rules and regulations on foreign markets? In order to gain the full synergies of any merger, the combined company would need to move quite rapidly to a single trading platform. This might be the cue. We know from experience with Sarbanes-Oxley that American legislators need little excuse to try to impose US accounting, securities and business standards on foreign jurisdictions.

The effect on London's competitiveness as a financial centre would be hugely damaging. The New York Stock Exchange fully recognises this point. In a recent address to the House of Representatives financial services sub-committee, the chairman of the NYSE, Marsh Carter, lamented America's loss of competitiveness in capital markets, which he blamed roundly on the rising costs and burden of excessive regulation.

This is indeed one of the reasons why the NYSE wants to buy into Europe - as a hedge and foil against the decline in America's own position. Yet I'm not sure his remarks would have found much resonance with the committee, which is co-chaired by Congressman Oxley himself. To such policymakers, the solution lies in imposing the same burdens on everyone else, a distinctly European view you might think, but in truth just as common the other side of the pond as over here.

The obvious safeguard against any such ambitions would be to base the holding company outside the US, yet as things stand, this appears to be non-negotiable. Many of the same concerns would be raised if Nasdaq were to launch a full takeover bid for the London Stock Exchange. All these proposed marriages still have a mountain to climb before they can be finally brought before the altar.

j.warner@independent.co.uk

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