MPC's quarter-point cut may prove too cautious

First Choice cuts; BAA's big gaffe
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The Independent Online

There was another surge in the stock market yesterday, taking the FTSE 100 index back to within a whisker of its pre-September 11 level. The only way of rationally explaining this sudden rebound, since economic circumstances have plainly deteriorated very significantly since then, is by way of the policy action taken by central bankers in the US, Europe and now Britain in an attempt to revive flagging business and consumer confidence. That and the big extra fiscal boost President George Bush is planning to give the US economy in the wake of last month's terrorist atrocities. But for the events of 11 September, this action might not have happened, or not so quickly anyway, so there is a case for arguing that although the trough of the downturn may now be deeper, the upturn will be swifter.

Here in Britain, the Bank of England's Monetary Policy Committee has been more cautious than others in cutting rates. Even after yesterday's quarter-point cut, our short-term interest rates are significantly higher than both the US and Europe, this despite the fact that Britain's actual and projected inflation rate is lower. The UK economy will grow more strongly than any other G7 country this year, but just recently things seem to have deteriorated sharply. Shouldn't the MPC be bolder?

In the City and the media, there is an exaggerated view of what's really happening in the UK economy right now. Both these industries are already in recession, and a period of painful contraction is well under way. But even accepting that things are not so serious in most other sectors, it is hard to point to a single company of size which is expanding and taking on staff right now. As our analysis on page 18 shows, the announced job losses that have been happening over a range of different industries so far this year are dramatic enough.

Take into account the unannounced headcount reductions taking place in most private sector organisations, and the figures are much higher. There are jobs to be had for sure – in fast food, certain areas of construction, and the now fast-growing public sector. But there's little or nothing in the higher paid professions of accountancy, finance, IT, computing and management. All the anecdotal evidence points to a business downturn, which far from slowing, is gathering pace. Unless the conventional rules of economics have been entirely suspended, it cannot be long before consumer spending follows suit.

It may therefore be that the Bank of England is indeed being too cautious. The unusually fulsome statement that accompanied the rate decision yesterday points to some sharp divisions on the MPC. The statement doesn't specifically set out the opposing views, in the way the later published minutes of its meetings do. But reading between the lines, it is obvious what happened.

The interest rate hawks, led by the Bank's deputy governor, Mervyn King, cited revised data for the first half of the year showing that consumption and demand in Britain was growing faster than previously thought, and was certainly much higher than other G7 countries. What's more, early indications are that the direct impact on the UK economy of the terrorist attacks will be a good deal less severe than in the US. We already know, for instance, that retail sales in the UK were barely affected by the events of 11 September. This faction continues to believe that there won't be a recession in the UK.

On the other side of the table, the doves point to the need for pre-emptive action to prevent a further deterioration in business and household spending. In the end it was they who gained the upper hand, but the still sizeable hawkish tendency instructed the compromise of a quarter point, rather than the full half-point some had demanded.

Who knows? Mr King may yet be right, and certainly the wait and see approach continues to be a reasonable one to take. In the autumn of 1998 there was a fair degree of certainty that there would be recession. But in the end there wasn't. Business confidence recovered from the shock of the Russian debt crisis as rapidly as it had collapsed. The sudden revival in the stock market points to something similar this time around. Unwise to count on it, though.

First Choice cuts

First airlines, now holiday companies. The pain is spreading fast. There have been rumblings about job losses from the travel companies for weeks, but First Choice Holidays, Britain's third largest tour operator, is the first to come clean. Its decision to cut 1,100 jobs, or 10 per cent of its workforce, looks draconian but it will surely not be long before Airtours and the German-owned Thomson follow suit.

Make no mistake about it, this is an industry whose colour is fading faster than a Mediterranean tan. Since the terrorist attacks on the United States, bookings to US sun spots like Florida are down 50 per cent, winter bookings are down 40 per cent and bookings for summer next year down by 30 per cent. Furthermore, those holidaymakers that do take the plunge are booking later, by which time the desperate travel agent has been forced to cut the price to cost or less.

Even so, there must be a suspicion that First Choice is over reacting. Capacity has been cut by 15 per cent for the first half of the winter season and 20 per cent for next summer. Capacity to Turkey and Morocco, which First Choice specialises in and for obvious reasons is thought particularly vulnerable, has been slashed by a thumping 40 per cent.

Has First Choice cut too far too soon? There's every chance the slump in demand will turn out to be a short-term blip. The big fear in the industry, however, is that the fall off is about more than just a short-term fear of flying. If it is as much to do with consumer caution ahead of an impending economic downturn, then plainly things are much more serious.

First Choice may indeed have over reacted, but only because it believes it better to be safe than sorry. In the past, Britain's tour operators have tended to judge their success by reference to market share alone, whatever the cost. Cutting capacity has been anathema. The industry has been forced to learn the stupidity of this approach the hard way. In any case, companies can always put back on extra capacity later if demand recovers. For now though, that looks like a very big if.

BAA's big gaffe

It was an odd choice of venue for a market sensitive announcement. Having repeatedly denied the stock market any news of how the terrorist atrocities had effected his business, Mike Hodgkinson, chief executive of BAA, chose a reception at the Labour Party Conference in Brighton to blurt out that his profits would be down by 20 per cent this year. He apparently didn't think this any more than "a drop in the ocean", though perhaps the bonhomie of the occasion loosened his tongue. In any case, the City might have been rather more interested in hearing the forecast than the Labour Party conference. Mr Hodgkinson has already announced a successor to step into his shoes some two years from now. Perhaps he should accelerate his plans.