Outlook: Another right royal ONS screw-up has the Bank fuming

Air France/KLM; Royal & Sun rights
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The Independent Online

There are lies, damn lies and statistics, Benjamin Disraeli, the former British prime minister, famously remarked. Cliche it may have become, yet it is hard to think of a more appropriate slogan for the latest débâcle to overtake the Office for National Statistics. Ten basis points of variation is neither here nor there, but to discover that growth in the second quarter was double what the ONS originally said it was is scandalous.

To get this in proportion, the impact on interest rate policy may not have been as significant as the City seems to think. The Bank of England's Monetary Policy Committee was not in receipt of the second quarter GDP figures when it last cut rates in July. The minutes to that meeting refer to a downward revision to the first quarter numbers, which as if on cue were yesterday upwardly revised once more, and to continued weakness in the economy in May, but the MPC wouldn't have known at that stage just how dire the ONS's second quarter numbers would be.

Furthermore, by the time of its last meeting, the MPC was caustically dismissive of the ONS assessment, describing the idea that consumption could be growing at 1.3 per cent yet output at only 0.3 per cent as "implausible". It complained that it was particularly difficult to assess the state of the UK economy because of the unreliability of the ONS numbers. Yet it still thought it inappropriate to reverse the interest rate cut.

None of this forgives the ONS's carelessness. A rather better excuse is that the root cause of the underestimate lies with the Department of Trade and Industry, whose model for assessing the amount of construction activity going on in the economy seems to be all at sea. None the less, the buck stops with the ONS, and whatever the reason, the numbers turned out to be completely wrong.

Setting interest rates or fiscal policy on the basis of what the ONS says is happening to the economy seems to have become a case of the blind leading the blind. This is not the first time the Bank has had cause to complain. Back in the early days of the MPC's existence, the ONS changed its methodology for calculating earnings growth, causing the figures to fluctuate violently and instructing a tighter policy than was necessary.

Alan Greenspan, chairman of the Federal Reserve, has always eschewed the tyranny of targeting the growth or inflation numbers. Instead he prefers a more touchy feely approach to interest rate setting, a style that has been criticised in markets as untransparent and patrician. Yet if the figures are as wrong as the ONS has got them, there may be something to be said for the Greenspan method. The ONS is meant to provide reliable compass points. Without them, policy is little more than guesswork.

The ONS has become a comedy of errors. It double counted the stock of pension wealth in the economy, it mis-stated the trade figures by failing to understand the importance of the carrousel mobile phone fraud in the amount of imports coming into the country, the retail sales figures have fluctuated so violently that nobody can take them seriously any more, and it ridiculously sided with the Government in ruling that Network Rail loans should not count as part of the public finances, despite the fact that they carry a Treasury guarantee.

In the last spending review, the Government earmarked a further £75m to helping the ONS improve its game. Let's hope it works. Both fiscal and monetary policy may have been operating on the wrong assumptions. Nevermind the capital markets, which have been equally misled. For a developed economy, this is a state of affairs.

Air France/KLM

The merger of Air France and KLM may well be the trigger for more consolidation among Europe's airlines, yet it is unlikely to provide the blueprint that others will want to follow. Hot of the runway is a classic piece of euro-fudge. Both airlines retain their identity, their respective networks, their hubs and above all their workforces, without a drop of blood being split.

This will presumably keep the unions happy and help the Dutch to save face in Amsterdam as they disappear into the belly of the government-controlled Air France. But it is far from obvious that it will deliver the benefits that either investors or passengers want.

For KLM, it is a takeover in all but name. Meanwhile, the French are overpaying in order to get the agreement of the Dutch, which is why the Air France share price nose-dived yesterday. In order to protect KLM's landing rights outside its European backyard, the two airlines have had to come up with a complicated ownership structure whereby Air France owns 81 per cent of the enlarged business but Dutch interests continue to control 51 per cent of the bit which is still KLM.

All sorts of consequences stem from having to retain KLM as a distinct airline with its own brand, identity, fleet and workforce. Not least, there must be a big question mark over where the cost savings will come from and how they will be achieved. The target of 495m euros in savings after five years is not exactly a stretching one for a business which will have a combined turnover of 19bn euros, but even this modest goal must be in doubt.

Likewise, the timeframe for completing the merger and receiving regulatory approval on both sides of the Atlantic looks extraordinarily optimistic. British Airways had two stabs at merging with KLM and drew a blank each time. It spent even longer attempting to force a transatlantic alliance with American Airlines, only to concede defeat. The main obstacle in both cases was regulatory.

It may help the Franco-Dutch case that both the French and the Dutch have open skies agreements in place with the Americans, whereas the Brits still do not. But what is really needed to make airline mergers work is the creation of a common aviation area between the US and Europe, where Brussels negotiates landing rights collectively with Washington. As BA's Rod Eddington observed yesterday, it will be a marathon not a sprint to get there. The same may end up being true of the Air France-KLM merger.

Royal & Sun rights

When Royal & SunAlliance announced a £1bn rescue rights issue a month ago, I lambasted the company and its advisers for unnecessarily incurring more than £30m in underwriting costs. Given that the issue was deeply discounted, it seemed incredible the underwriters would ever be called upon. It was money for old rope, I wrote, from a company that could ill afford to be profligate.

I was totally wrong. The shares have been sinking ever since and after a fall of another 4.7 per cent yesterday, taking the collapse in the share price since the rights issue was announced to more than a third, there's now every chance of the underwriters being left on the hook. Another 11p fall in the shares and the rights will be valueless. For the new team at the top, John Napier as chairman and Andy Haste as chief executive, it would be an appaling start to what was meant to be a new beginning.

The problem they've got is that the rights announcement forced the disclosure of a truly terrible state of affairs at Royal - far worse than the City had up until then appreciated. As Morgan Stanley succinctly put it yesterday, what they have done is "raise the maximum capital possible rather than what was actually required to put the group on a sound footing", and then made the numbers fit around it.

Morgan Stanley reckons that the £500m of extra provisions set aside for the US business falls short of what would be prudent by nearly £300m. The capital raising therefore leaves no scope for more shocks or disappointments. The rights issue, and with it what little remains of Royal's stock market credibility is sitting on a knife edge as the hedge funds move in for the kill. It will require all Cazenove's powers of persuasion to prevent a rout.

jeremy.warner@independent.co.uk

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