Jeremy Warner's Outlook: Markets may be underestimating potential for more interest rate rises this summer

Energy White Paper delayed again; Metronet fast heading for buffers
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The Independent Online

How much higher are interest rates likely to go? The markets are already pricing in at least one more rate rise to 5.75 per cent. On the other hand, the majority of City economists as polled by Reuters think that, at 5.5 per cent, we have reached the peak.

The Bank of England's statement yesterday gave few clues, though it did refer to limited spare capacity in the economy, firm output growth, stronger than expected business investment and increased pricing power. This may suggest a continued tightening bias. In any case, we should learn more about the Bank's view next week, when the quarterly Inflation Report is published.

My own view is that both the markets and City analysts have misjudged the degree of inflationary pressure building up in the system, and therefore the need for more rate rises. The world economy continues to boom and may be stronger still by the end of the year, by which time the current slowdown in the US should have run its course.

The outlook for Europe remains encouraging, while it is hard to see what might upset the Asian juggernaut. The prospect of a crash in the Chinese stock market, which has been driven to crazy heights by the manic buying of retail investors, is certainly concerning, but unlikely to interfere with the fundamentals too much. In other words, the present boom has got quite a bit further to run yet, and that may eventually push the British bank rate to 6 per cent or higher. The Bank of England cannot risk a further blow to its credibility by getting it wrong on inflation again, and may even have acted too cautiously with yesterday's quarter-point rise.

As the Prime Minister reminded his audience in yesterday's valedictory speech, Britain has enjoyed unprecedented prosperity over the past 10 years. The City, the South-east and even the regions are booming as never before. New millionaires and billionaires are being created at record speed.

Yet the blunt truth for New Labour is that, though the disposable incomes of ordinary people grew strongly throughout most of its first two terms of office, they are now being quite severely squeezed. A combination of rising taxes, inflation and interest rates means that on average people are getting less well off. Spending at previously inflated levels floats on a sea of debt and rising house prices.

For all these reasons, bank rate may eventually have to hit 6 per cent. That's not exactly a great backdrop for Gordon Brown to begin his premiership, though he may be able to take comfort from the fact that rates were as high as 7.5 per cent as recently as 1998. That, however, was before the main onslaught of the present credit boom. Rates at that level today would probably induce a recession. Even 6 per cent will feel painful for many householders, and, for quite a number, will break the bank.

Energy White Paper delayed again

Is this the third or the fourth time the Government's Energy White Paper has been delayed? It's hard to keep count, but the last "definitely, definitely" deadline of 17 May pencilled into the Department of Trade and Industry's diary has again been rubbed out and a new date some time in the first week of June entered into the books.

The conspiracy theorists were out in force to speculate on the reasons for the latest delay yesterday, but the most likely explanation is that sheer weight of preparation and consultation has again got the better of officials and ministers. Either that, or it's something to do with Tony Blair's long goodbye. Energy policy has always been Mr Blair's baby, rather than that of the Chancellor, Gordon Brown. What to do about Britain's energy needs fits the PM's twin concerns of climate change and national security hand in glove.

Mr Brown had to be dragged kicking and screaming into going along with the recommendations of Tony Blair's pensions tsar, Lord Turner, and it is still not entirely clear that he'll implement them.

I'm not aware of him holding particularly strong views one way or the other on energy, other than that new nuclear build should not be allowed to cost the taxpayer a penny, but, since anything that comes out of the Energy White Paper will now be his policy, he'll no doubt be reading the fine print with more than usual attention to detail. This is especially the case as he is said to be planning to absorb the bulk of the DTI into the Treasury when he becomes Prime Minister.

Interestingly, Gordon Brown's brother, Andrew Brown, is head of communications at EDF, the French state-controlled power company, and as such is one of the chief lobbyists in favour of new nuclear build. For obvious reasons, Brown senior keeps his younger brother at arm's length, but, as far as is known, he doesn't share Old Labour's loathing of all things nuclear. Indeed his commitment to Trident suggests he positively embraces it.

The last delay in publication of the White Paper was caused by a laudably mischievous intervention by Greenpeace, which persuaded a High Court judge to brand the Government's earlier energy review, in which it gave the go-ahead for a new generation of nuclear power plants, "inadequate, misleading, and procedurally unfair".

Officials have since been working overtime to produce a nuclear consultation document which will be published alongside the main Energy White Paper. Having fully consulted, the Government will in time-honoured manner merely plough ahead with what it always intended.

Yet whatever it does to speed the next generation of nuclear build, the new stations are unlikely to be up and running in time to plug the yawning gap in Britain's energy need that will open up over the next 10 years as older stations are decommissioned. As a stop-gap, it will have to be filled by gas-fired stations. That will make Britain highly dependent on imported gas for its electricity needs.

The other two key issues for the Energy White Paper are related to climate change: energy efficiency and renewables. Policy on renewables is still a mess, while the energy industry's finest brains still struggle to work out how the Government is going to achieve its targets for energy efficiency in the home without by diktat forcing householders to spend money on insulation and condenser boilers. Still, all will be revealed in early June, won't it? Don't hold your breath.

Metronet fast heading for buffers

Things seem to be a great deal more serious at Metronet, the private-sector consortium responsible for modernising a large part of the London Underground, than generally appreciated. One City source describes the situation as in "meltdown", while another is of the opinion that the potential for calamity is now so great that it could undermine the whole concept of public-private partnerships.

Last November the PPP arbiter for the Tube found that Metronet was on course for a £750m cost over-run on the first phase of its contract, and, though no final decision has been made on who is responsible, he seemed largely to blame inefficiencies at Metronet. Insiders now suggest that the true figure is a great deal higher.

The exact size of the liability was an issue last year when private equity houses were bidding for Thames Water, one of five partners in Metronet. Due diligence revealed the true cost overrun to be at least £1.2bn. That figure is said to have inflated further since then.

Under the terms of its contract, Metronet is already liable for the first £100m of the overrun, with the arbiter, Chris Bolt, set to adjudicate on the rest. Metronet has been trying to persuade London Underground to split the difference, possibly by agreeing to compromise the amount of modernisation that needs to be done. These talks are thought already to have reached an impasse.

Who is liable, and if, as seems likely, it is Metronet, how are its partners and bankers going to split the bill? Big write-offs seem inevitable. As Eurotunnel proved all those years ago, private-sector money and large holes in the ground don't mix. The main criticism of the PPP used to be that of profiteering at the public's expense. The record rather shows that it is a formula for losing your shirt.

j.warner@independent.co.uk

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