Jeremy Warner's Outlook: Is the Bank of England right to be so bullish? Beware the storm clouds on the horizon

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So everything's fine in the macroeconomy, is it? That was the outlook postulated in last week's Inflation Report, whose three to four-year forecasts painted a picture of such benign stability that they might have been penned by the Chancellor himself. In any case, he could scarcely have hoped for a better write up, with inflation bang on target for the next three years and growth returning to a little above trend and then staying there. Is this really what the Bank of England's Monetary Policy Committee believes?

If there was any room for doubt, it was laid to rest yesterday by publication of the minutes for the MPC's last meeting. Far from showing a strengthening of the case for more interest rate cuts, as many in the City had expected, they instead show the committee in surprisingly upbeat mood and virtually unanimous in voting for rates to be left on hold. Only one member of the MPC, Stephen Nickell, voted for a rate cut, as he has done for some months now. City speculation that he had been joined by others turned out to be ill founded.

To the contrary, sentiment seemed to be almost hawkish, with members worrying that a reduction in rates at this stage might provide further support for the housing market and consumption at a time when GDP growth was already strengthening. The Governor, Mervyn King, has been careful to warn against complacency, yet it's hard to find cause for concern when the outlook is painted as rosy as this.

So where do the risks lie? Well of course there is always the possibility of catastrophe - another terrorist atrocity, meltdown in the Middle East, a pandemic of avian flu, or a sudden acceleration in climate change. Yet these are risks that are always with us and by their very nature are largely unpredictable. We can put in place crisis management plans to confront them should the worst come to the worst, but it would be pointless trying to predict them.

Then there is the risk that Europe's still-fragile economic recovery won't continue as predicted. This seems a rather more potent cause for concern than the possibility of a human variant of avian flu, for Europe has a long and distinguished history of stalled economy recovery. Nothing has obviously changed to make us think that this time might be different. Britain would meanwhile seem to face its own particular challenges, with a fast-expanding public sector crowding out a once-vibrant private sector.

Yet the biggest threat is the one that economists have been complaining of for many years now - the growing imbalance in global trade and capital flows. This finds its most obvious manifestation in America's yawning current account deficit, which just gets bigger by the day.

The only reason it hasn't already self corrected with a violent collapse in the dollar and an equally dramatic rise in American interest rates is that it is supported by massive inflows of capital from Asia and the rest of the world. Implausible though it may seem, excessive consumption in the world's richest nation is being paid for by the savings of some of the poorest nations. Though this relationship has persisted for some years now without calamity, nobody could believe it remotely sustainable.

The best hope is that it corrects slowly and in an orderly fashion. Such an outcome is still in my view the more likely one. The exceptionally loose US monetary conditions which have helped bring about this strangely anomalous state of affairs are being steadily withdrawn. The upsurge in US consumer prices announced yesterday means the Fed will remain in tightening mood for some months to come yet.

More importantly, there is every reason to believe that Asia will itself eventually develop decent levels of domestic demand, making its further development and growth less dependent on exports.

Yet this is plainly still some years off, and in the meantime there is some risk of the imbalances correcting more violently. One of the other consequences of the exceptionally loose monetary conditions of the past five years is that traditional standards of risk assessment are being progressively thrown to the winds.

This has manifested itself not just in rapidly rising house prices and growing levels of household debt, but in a steady erosion of interest rate spreads. The difference between junk and triple A rated debt is these days little more than 300 basis points, against 850 only a few years back.

There has been an equally dramatic narrowing of the spreads between developed and emerging market debt. The US may have problems, but it has never once defaulted on its debts. Given the choice between US Treasuries at 4.5 per cent and Republic of Pakistan bonds at 9 per cent, I know which I'd rather hold.

The point is that when money is cheap and plentiful, investors grow oblivious to risk and in an increasingly desperate search for yield lose all sense of capital discipline. This in turn makes the world's financial system highly vulnerable to shocks. Any sudden widening of spreads brings with it the risk of severe losses, a credit crunch, and the possibility of violent economic and financial correction.

So despite the glowing report card evident in yesterday's MPC minutes, the Governor is right to warn against complacency. Britain is only the US in microcosm. Our high levels of debt and growing trade deficit make us extraordinarily similar. The strong likelihood is that nothing will happen to spoil the sunshine of economic stability forecast in last week's Inflation Report, yet the storm clouds are all too obviously building. It's only a fool who ignores them altogether.

A new lease of life for Longbridge?

When it comes to Longbridge, scene of the longest road crash in British motoring history, hope seems to spring eternal.

Thus it is that the Chinese motor company which bought MG Rover from the receivers last year has signed a new 33-year lease on part of the site with the apparent intention of employing up to 1,000 workers to restart production of the MG TF sports car.

The signing was announced at a triumphant press conference yesterday. Were it not for the unfortunate connotations, one might even talk of Longbridge again rising, Phoenix-like, from the ashes. The Transport and General Workers Union welcomed the deal, the local MP welcomed it, and so did Birmingham City council. Smiles all round. A once-proud name in British motoring history rescued again.

Yet in reality how committed are the Chinese to this triumph of hope over experience? Not very to judge by the six-month get-out clause in the contract. If for any reason Nanjing Auto changes its mind, it can walk away. Unfortunately, it is rather hard to believe it won't. Nanjing presumably wouldn't have signed the new lease if it were not serious. It was under no obligation to do so.

Yet I'd be amazed if the production lines were ever to hum again. Nanjing's main purpose in buying Rover was to use its knowhow and tooling to produce low cost cars back in China. Why it would want to resume car production in Britain, one of the most competitive, high-cost and over-provided-for auto markets in the world, other than perhaps for reasons of prestige or political face, is something of a mystery. Or perhaps the purpose is just that of maintaining an outpost for the day when Nanjing is big and powerful enough seriously to attack the British market?

Whatever the reason, I'll believe it when I see it. The Phoenix Four kept Rover alive on the proceeds of a £500m dowry from the company's former owner BMW. It was a grubby and fruitless endeavour. The truth is that the money would have been much better spent on local regeneration than saving Rover. In the end everyone lost their jobs anyway and the dowry was squandered. I wish Nanjing luck in attempting to bring the British Patient back from the dead, but suspect that in the end he will be left to his rest.

j.warner@independent.co.uk

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