Jeremy Warner's Outlook: Inflationary expectations are rising with the oil price: Bank's next rate change may be up

Standard Life edges towards flotation; Goldman Sachs: when it pays to rein in
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The Independent Online

Hopes of another cut in interest rates, already fading fast, will be dashed for the foreseeable future by yesterday's Bank of England/NOP inflation attitudes survey. This shows that both people's perception of the current rate of inflation, and their inflationary expectations, are at their highest levels since the survey began.

Admittedly, these perceptions at 2.8 and 2.7 per cent respectively are not yet at a level to give the Bank of England serious cause for alarm. Yet the trend has been unrelentingly upwards in recent quarters, and since perceptions are two-thirds of reality, they will act as a clear warning to the Bank that monetary policy may still be too loose. In any case, the odds have again shortened on the next move in interest rates being up, not down - the latter being the prediction most pundits would have made just a month or two back.

Nor is it just the spectacle of ever rising fuel bills which is feeding people's inflationary expectations. The cost of many services fails to conform to the picture of benign inflationary behaviour the Chancellor likes to point to in his Budget speeches. The only reason the overall inflation rate looks as tame as it does is because of the price deflation in goods being exported out of a fast-industrialising Asia.

House prices, and any services associated with them, have yet properly to respond to the Bank of England's monetary medicine. With clothes, widescreen TVs, iPods and other must have fashion items of the modern world, the consumer can at least choose not to buy them if the price doesn't suit. There is no such choice with rising utility bills, train fares, or for that matter, the cost of getting your car or boiler fixed. The latest inflation attitudes survey is the strongest warning yet of impending second round inflation effects, where workers begin to think inflation is higher than it is and demand higher pay rises to compensate.

Recent figures show that average earnings are still in abeyance once the effect of the current, bumper City bonus season is discounted. Unemployment is also creeping steadily higher, which acts as another constraint on demand for higher wages. Furthermore, after a period of very rapid expansion and wage growth, in the public sector, the Chancellor is attempting to rein in. The funding crisis in the National Health Service may be resulting in some net reduction in public sector employment right now.

Yet these broad generalisations disguise a more complicated picture. Demand for many forms of skilled labour is still growing, particularly in the upper echelons of financial services, which thanks to the growth in the City, is now indisputably Britain's most successful industry. There is no complex banking transaction of any significance anywhere in Europe which doesn't today pass through the City in some shape or form. That's increasingly the case for the rest of the world too, creating vast new sources of fee income for City professionals and the services they provide.

In London and the South-east, this has made house prices and consumption less sensitive to domestic interest rate rises, and the further deflationary effect of rising energy prices, than might have been expected. Onerous building regulations in areas of the country where demand for skilled labour is at its highest has ensured that house prices have continued to rise at a fair old clip. As the cost of houses and associated services rise, those employees most in demand simply demand more pay, and generally they get it too.

None of this will be welcome news for less skilled workers or those in less buoyant areas of the national economy. Just as a one size interest rate has never suited all among members of the European Monetary Union, we may be seeing some of the same phenomenon in Britain, where a number of quite different growth and inflation stories have begun to assert themselves.

Standard Life edges towards flotation

How are the mighty fallen. Once one of the giants of Britain's life assurance sector, Standard Life, is limping towards stock market flotation on a likely valuation not much bigger than Friends Provident and little more than half the size of Legal & General, the next biggest. As for Aviva and Prudential, the Edinburgh stalwart looks but a minnow by comparison.

Would things have been different had the board not been so obstinate and bowed to pressure to demutualise when it was first seriously proposed, back in 2000? The great thing about such idle speculation is that the point cannot be proved one way or the other, but contrary to the opinion of many disgruntled members, the answer may be not much.

Had directors caved in to the demutualisation lobby back then, they might have made the required asset adjustment in their life fund at an earlier stage, which would have saved at least some of the subsequent destruction of capital. Yet given the time lag involved, Standard Life would have been gearing up for flotation just as the bear market for life insurers reached its most virulent. The shares given to members wouldn't have been worth tuppence, and the chances of raising the £1.1bn of new equity the company hopes to get this summer would have been zero.

That said, the £1,700 average members will receive in free shares - half of them will get only £500 to £1,000 worth - is plainly a lot less than they might have hoped for had Standard Life bitten the demutualisation bullet when others were doing it back in the late 1990s.

When asked why a company which had been so staunchly against conversion just six years ago is today recommending it as the only viable way forward, all the chief executive, Sandy Crombie, can do is lamely protest that solvency regulation got in the way, so that miscellaneous profits which were available to be distributed to members in the past are no longer there today. It is therefore right that shareholders, and not policyholders, take the risk of funding future growth.

Out of sheer bloody mindedness, some members might vote against July's planned flotation, but there would be little point in it. Even £500 is better than nothing at all; voting against won't improve the value of policies at maturity. To the contrary, it might be even further damaged. The more profit-driven approach to business which comes with demutualisation has meanwhile already done wonders for the bottom line.

The past practice of buying business, by over promising on bonuses and paying out large commissions to third parties, was plainly a costly endeavour. Just by stopping, Standard Life has transformed itself from loss into profit. There's a lot further to come on that front. Standard is therefore right to turn down those that have lined up to buy the company on the cheap as it has prepared for flotation.

Life assurers tend to be valued on the basis of embedded value - or the discounted value of future profits. At the projected stock market capitalisation of £4.8bn to £5.5bn, Standard would be at quite a discount to others. Assuming Mr Crombie has got what it takes to hack it in the publicly listed sector, there's still plenty of scope left for improvement, though I fear this once proud Scottish name will eventually be consolidated into oblivion whether it likes it or not.

Goldman Sachs: when it pays to rein in

Hank Paulson, the chief executive of Goldman Sachs, demonstrates foresight rare for an investment banker in instructing his London-based rainmakers to draw in their horns. At the top of each bear market there's always some investment bank that manages entirely to trash its reputation by going too far. In the 1980s, it was Morgan Grenfell. In the bubble, it was ... well, just about all of them.

The bid fever now sweeping the London stock market is an accident waiting to happen. Goldman Sachs is linked to virtually all of it, and is therefore almost bound to be involved in any forthcoming pile-up. Mr Paulson's warning is a precautionary shot across the bows of some of his overly enthusiastic juniors. Even in investment banking, protecting the franchise must sometimes take precedence over the pursuit of fees.