Outlook: It's an ill wind as central bankers fail to act on interest rates

Barclays Bank; Laura Ashley
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The Independent Online

Self-evident weakness in the economy should have made the Bank of England's Monetary Policy Committee cut interest rates yesterday. The fact that it did not is explained by concern over the housing bubble, and of course the recent fall in the value of the pound, which has clear inflationary implications. A subsidiary consideration would have been that to cut interest rates at a time when inflation is significantly above target might have triggered a self fulfiling expectation of continued high levels of inflation.

Self-evident weakness in the economy should have made the Bank of England's Monetary Policy Committee cut interest rates yesterday. The fact that it did not is explained by concern over the housing bubble, and of course the recent fall in the value of the pound, which has clear inflationary implications. A subsidiary consideration would have been that to cut interest rates at a time when inflation is significantly above target might have triggered a self fulfiling expectation of continued high levels of inflation.

In my view the MPC missed a trick in failing to act. All the above obviously give reasonable cause for the Bank to sit on its hands and do nothing, but the risk in the economy at the moment is still much more that of subdued growth or even recession than inflation. If that perception turns out to have been wrong, little harm would have been done by shaving another quarter point off the base rate. Any such action could in any case easily be reversed if it proves misconceived.

Interest rates are already so low that another quarter point would be unlikely to further inflate the housing market, but it might have helped rock bottom business confidence and revived flagging consumer confidence a bit too. Most companies feel a little better now that the geo-political uncertainty of Iraq has been removed, but they take a look around the world and they see Alan Greenspan, chairman of the Federal Reserve, raising the bogey of deflation in America, the reality of deflation in Japan and large parts of the rest of the Far East, and the near reality of it in Germany.

The overriding psychology is therefore still one of extreme caution. I know of hardly any private sector companies which are committing to major new investment right now. Show us unambiguous evidence of a sustained upturn, they say, and then we might be prepared to think about it.

The key new ingredient to the interest rate equation is the rapid depreciation of the pound. Since the beginning of the year, it's fallen around 8 per cent against the euro taking it back to where it was when the euro was first launched. It has also fallen sharply against all other major currencies except the even more sickly dollar, which the markets have blindly decided to trash.

It's hard to know quite what to make of this phenomenon, for it is not as if the core eurozone economies are obviously better places to invest than the UK. In part it is explained by the conflicting noises coming out of Downing Street over the Government's position on the euro. The present dithering is the worst of all possible worlds, for if the capital markets sense an uncertainty, they vote with their feet. None the less, the fall in the pound ought to be a boon to Britain's beleaguered manufacturing industry, making its goods more competitive both at home and abroad.

Personally, I'm not convinced it will make as much of a difference as some believe. The trouble is that all the world's major economies need a competitive devaluation in order to generate an export led recovery. Ironically, it is only the two strongest economies, the US and the UK, which are getting it, but it doesn't much help if there is no demand in the economies you are devaluing against. In a deflationary world, everyone is up the proverbial without a paddle, however weak or strong their currency.

In any case, the weakness of the pound may have allowed the Bank of England to adjust its growth forecast to a level which is not so embarrassingly out of kilter with the Chancellor's as it was. Against the Treasury's forecast of 3-3.5 per cent growth next year and the year after, which is just fantasy, the Bank was pencilling in something nearer 2 in the last inflation report. Since then the pound has fallen way below the level then assumed, and so has the oil price, allowing the Bank to add perhaps half a percentage point or more to its longer-term growth forecasts. We'll see. The new Inflation Report is published next week.

In the meantime, this doesn't feel like the sort of economy where inflation is about to take wing again. The prevailing mood is still one of gloom and possibly quite difficult times ahead. Still, at least the Bank has got some sort of a case for leaving rates on hold. The same cannot be said of the European Central Bank, which seems entirely to have lost the plot. If interest rates should have been cut here, they certainly should have been cut in Europe, where only in Greece, Spain, Portugal and Ireland is inflation anything like a serious problem.

The Cologne Institute of the German Economy yesterday described business sentiment in the country as "catastrophic". Without the considerable contribution from exports, the economy would be in recession again right now, the Institute said. As can readily be seen, Germany needs a strong euro like a hole in the head.

Barclays Bank

What is it about British banking's love affair with Spain? Royal Bank of Scotland's relationship with Banco Santander is now so strong that only death would seemingly part them. It has never been entirely clear what the two get out of their cross shareholdings and common directors. What is clear is that some deep personal bonds have developed between the two of friendship and mutual respect. If either of them ever got into the trouble, the other would raise hell and high water to come to their partner's assistance.

Now Barclays has announced plans to acquire Banco Zaragozano for €1.14bn, ending a long search for a European partner. Given that the bank's controlling shareholders, a couple of convicted fraudsters who came by the shares as part of parallel divorce settlements with two sisters, have already agreed to sell, the deal is as good as in the bag. The benefit of the acquisition to Barclays is more obvious than with the RBS relationship with Banco Santander, as Barclays already has a sizeable presence in Spain and can therefore gain cost and synergy benefits by crunching the two together.

But why are British bankers gravitating towards Spain, rather than spreading their seed more widely across Europe? One reason is that the cultural, financial and legal gap is less severe than elsewhere in the eurozone. Nobody in there right mind would buy a bank in Germany right now, even though there are plenty on offer, while France still seems too alien to command serious consideration. As for Italy, forget it. No due diligence could ever uncover the byzantine maze of interlocking relationships and hidden deals that supports the Italian banking system.

Spain, on the other hand, is the bit of the eurozone economy which most closely resembles our own - faster growing, more deregulated and with a well capitalised and strong banking system. Furthermore, Spain has plenty to teach the Brits about cross selling of financial products, which is much higher in the land of Sangria and flamenco than banks have ever achieved here.

The stock market reacted negatively to the deal yesterday, but it is hard to see why. True enough, this is a cash acquisition, which means in future there will be less money for share buybacks, but Barclays is fast running out of road for expansion back in the UK and this is a low risk transaction which gives the bank an important toehold in one of the eurozone's more promising economies.

Laura Ashley

Many have tried to reverse the decline fortunes of Laura Ashley, but so far no one has succeeded. The latest plan to split the top job between joint chief executives scarcely looks any more promising. The company's controlling Malaysian shareholders must have lost a packet on the business since they marched in, determined to make Laura Ashley into another Burberry's. Today the two are further apart than ever, not even remotely in the same league in the branded goods market. There may be a salvageable business in there somewhere, but the brand is now so battered and war weary that it is hard to known what it is.

jeremy.warner@independent.co.uk

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