Outlook: A runaway boom, or just a temporary respite?

Equitable voting; Insurance penalty
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The Independent Online

It was just four short months ago, but economically it is almost as if 9.11 never happened. Speaking on behalf of G10 central bankers after a meeting in Basel, Switzerland, yesterday, Sir Edward George, Governor of the Bank of England, said that signs of economic recovery were beginning to emerge in both the US and eurozone. Back home in Britain, meanwhile, consumers have embarked on a low interest rate fuelled spending spree of spectacular proportions.

It was just four short months ago, but economically it is almost as if 9.11 never happened. Speaking on behalf of G10 central bankers after a meeting in Basel, Switzerland, yesterday, Sir Edward George, Governor of the Bank of England, said that signs of economic recovery were beginning to emerge in both the US and eurozone. Back home in Britain, meanwhile, consumers have embarked on a low interest rate fuelled spending spree of spectacular proportions.

As if to underline the extent of it, new car sales rose an astonishing 17 per cent last month according to figures published yesterday, taking both showrooms and manufacturers, who were anticipating the usual seasonal slowdown, by surprise. There were no doubt many things Sir Edward thought he might be accused of as he contemplated the weight of his task in the aftermath of the terrorist atrocities in New York, but fuelling a boom is unlikely to have been one of them.

Four months ago, we seemed to be staring financial and economic armageddon in the face. Hardly anyone would hold that view today. Few in the City believe interest rates in Britain will go any lower, and indeed Sir Edward has already in effect tightened monetary conditions by talking openly about the possibility of reversing rate cuts in order to choke off the consumer boom. Both short and long-term market rates have risen since he made his remarks. Some on the Monetary Policy Committee will be arguing for overt tightening at this week's meeting.

At the time of the terrorist attacks, the Bank of England was widely criticised for being too cautious in its response. In the immediate aftermath, it cut rates by just a quarter point, in marked contrast to the US Federal Reserve and the European Central Bank, both of which went the full half-point. Sir Edward will be congratulating his judgement in not being panicked into going further. But at the same time he'll be viewing the tightrope the Bank of England seems to be walking with mounting concern.

Any further cuts in rates would be folly given the extent of Britain's debt-fuelled consumer boom. On the other hand, any increase would bring further pain to Britain's already pole-axed manufacturing sector and might stop in its tracks the still nascent recovery in business confidence.

The car sales figures tell their own story of boom and bust, for behind the surge in sales, there lies a tale of crippling losses for Britain's own car manufacturing sector as it struggles to cope with fast growing, cheap foreign imports. Stripping out foreign produced cars, sales were down markedly last year. In less exaggerated form, the same is true for vast tracts of the rest of Britain's beleaguered manufacturing industries. The two speed economy is back, and this time it's serious.

Monetary policy has worked as it's supposed to in saving the economy from a plunge in consumer confidence and outright recession, but at what cost? Record levels of household debt will bring their own problems when rates begin to rise again and, if business fails to catch the spending bug, then things might begin to look very nasty indeed. No wonder the stock market remains so sceptical. The present consumer boom may turn out to be little more than a temporary respite.

Equitable voting

The Royal Mail allowing, there's still time to vote by post for Friday's meeting of Equitable Life policyholders. Those not intending to go to the meeting at Wembley Conference Centre in the London suburbs, need to get their votes in by tomorrow morning at the latest so, for many, today is the last chance. Given the potentially dire consequences of failure, it's hard to believe the compromise proposal is going to fail, but to judge by the panicky utterances of Equitable's emissaries over the weekend, it wouldn't be wise to bet on it.

The main problem seems to be the 6,000 or so group pension schemes with their money invested in the Equitable. The proposals only need 50 per cent of policyholders by number to vote in favour, but 75 per cent by value, so the position of these schemes becomes crucial, and so far many of them have been shy in coming through with their votes.

The Equitable board is hoping that this is because trustees have been diligently taking independent advice and, a bit like institutional shareholders in a takeover bid, are waiting until the last minute to vote. Just in case their tardiness is down to forgetfulness, however, Equitable is warning trustees that they could get sued for negligence by group members if they fail to vote one way or the other.

For the overwhelming bulk of policyholders it makes sense to vote in favour, regardless of whether they are a guaranteed annuity rate policyholders or not. If GARs attempt to hold the society to their rights, Equitable is likely to get sued for mis-selling by anything up to 40,000 non GARs, who will reasonably be able to claim they bought their policies without knowledge of the looming GAR liability. There's only so much money to go around and, at Equitable, robbing Peter to pay Paul is a zero-sum game.

Some members will vote against out of sheer bloody mindedness, regardless of any further financial loss their actions might cause. But satisfying and understandable though such a course of action might be, it will ultimately benefit no one. It's time this whole ghastly mess was laid to rest. Vote in favour and do it now, lest your abstention makes the difference between success and failure.

Insurance penalty

The extra £150m general insurers are being asked to fork out to cover claims from policyholders of the collapsed insurance companies, Independent Insurance and Chester Street, isn't much when shared around, but even so it is the highest the industry has ever had to pay into its compensation scheme and comes at a time when even the most solvent firms can ill afford to see their reserves further depleted. As such, it is bound to raise new questions about the appropriateness of an industry-wide insurance protection scheme.

The Financial Services Compensation Scheme (FSCS), was set up in the early 1970s after the collapse of Vehicle and General, which left thousands of policyholders with unpaid claims. Since it is illegal not to have insurance cover in many instances, car insurance being only the most obvious, and since regulators have an unfortunate habit of disclaiming all responsibility when things go wrong, it was deemed necessary to make the industry as a whole liable to meeting unpaid claims.

For every apparently sound public policy objective, there's nearly always a downside, and this instance it was to encourage the development of a negligently or fraudulently run operator. Policyholders didn't have to worry about whether the rates being charged by Independent Insurance were too good to be true, or the capital adequacy of the company, because they knew the company was underwritten by the FSCS. The trouble with compensation schemes is that it is always the good guys that end up bailing out the bad. Little wonder that many in the industry are openly questioning whether the FSCS is such a great idea after all.

j.warner@independent.co.uk

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