Outlook: Rate setters ride their luck as house prices roar

Tunnel showdown; Grade's conflict
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The Independent Online

To raise or not to raise? On Thursday, the rate setters at the Bank of England face their toughest call since, well, since the last time they actually had a call to make. The outcome of the Monetary Policy Committee's monthly meetings are generally foregone conclusions. Not this time.

Judging by the reports, the members of the MPC are almost as divided as the City about whether to leave the cost of borrowing on hold or increase it from the present level of 4 per cent. Yesterday's industrial output figures may not have made the decision any easier, fuelling, as they did, worries that sterling's upward trajectory has put the skids under the nascent recovery in manufacturing.

As the Bank's Governor, Mervyn King, never tires of telling us, however, the interest rate the MPC announces on Thursday is designed to target a given inflation rate two years out, not counter-act the latest disappointing economic indicator.

If the inflation rate two years hence were all that mattered, then there would be a strong argument for keeping rates unchanged. With one glaring exception, price pressures remain relatively subdued, there is little evidence of a build-up of inflationary wage demands, the international outlook is benign (although a decisive surge in the US economy could change all that) and inflation itself, as measured under the Government's new index, remains way below the Bank's 2 per cent target.

Moreover, the anti-inflationary effect of a strong currency, which is currently occupying some MPC members, adds to the case for keeping rates on hold because a healthy sterling equals cheap imports.

The missing piece of the jigsaw is, of course, the housing market, which continues to roar along at a rate which no one expected, least of all the MPC. The mortgage industry retorts, rather smugly, that affordability is the key but since this depends very heavily on the Bank keeping a lid on rates, it is specious argument.

Everything else about house prices - from the annual percentage increase to their ratio to average earnings - screams that the market is about to go bust. The issue then becomes how to manage a gradual slowdown in house prices. Another quarter-point rise in rates may well be factored into the housing market already. On the other hand, a half-point rise, as some would urge, could be the tipping point which preciptates a collapse.

For the past two years the Bank has stuck doggedly to its central projection that house price inflation will abate to zero two years out and it will take some Damascan conversion to change that view radically come next month's quarterly inflation report.

The truth is that the Bank has consistently misread the housing market and although it is hardly alone in that, it has tended to mean that it has got monetary policy right by default. Indeed, rewind two years to the quarterly inflation report in February 2002 and a number of the assumptions which underpinned the Bank's decision to keep rates on hold then - incidentally, at 4 per cent - look a little bit out of kilter.

In the same way that Gordon Brown has, in some respects, been a lucky Chancellor, so the Bank has ridden its fair share of luck in the aftermath of 11 September in setting monetary policy. However, its luck cannot last forever.

Tunnel showdown

The Queen travelled through the Channel Tunnel to France yesterday but it is going to take a lot more than the patronage of the Royal family to save its operator. Eurotunnel has a debt burden which almost makes the Civil List look a model of parsimony by comparison. At the moment, it is allowed to service this debt (£6.4bn, since you ask) by paying interest to its bankers in the form of share certificates rather than cash. However, this convenient arrangement runs out in two years' time. Worse, the gravy train known as the minimum usage charge also ceases to apply to through-rail operators such as Eurostar, depriving Eurotunnel of a tenth of its revenues.

At this point Eurotunnel meets its Waterloo. Either the banks take over or they agree to take a massive haircut, massaged into doing so by some so far ill-defined deal with the UK and French governments which finally places Eurotunnel on a viable financial footing.

As you read this, some of the cleverest investment bankers in London are working out just how the taxpayer can bail out the Tunnel, even though public subsidy is explictly forbidden by the Act which brought the link into existence.

Even before their idea has seen the light of day, however, a group of pesky French shareholders led by the colourful activist Nicholas Miguet is trying to derail the plan. It has tabled a motion at tomorrow's Eurotunnel annual meeting calling for the British chief executive Richard Shirrefs and the rest of the board to be thrown from the footplate and replaced by a slate of exclusively French nationals. The nearer the decisive meeting has got, the less cordiale has become the entente between the board and the rebels.

The protagonists at least agree on the problem - the tunnel cost too much to build while the traffic forecasts were hopelessly optimistic. But their solutions could not be more different. Eurotunnel wants to slash charges to generate more traffic and write off its debts by issuing new shares to the railway operators and bonds guaranteed against future income.

The rebels, on the other hand, want to double charges, force the banks somehow to forgive their debts and then rely on the two governments to bridge the gap when the tunnel's revenues inevitably crash. It would not even get that far, because the banks would have pulled the plug long ago and exercised their right to take over.

And yet, insane as the rebel plan may be, it has an outside chance of being voted through because 60 per cent of Eurotunnel's shares are owned by one million, mostly disgruntled, private French investors. The Brits long since took the money and ran or else held on in tiny numbers for the travel perks which being a founder shareholder guarantee.

A win for the rebels would be some slap in the face for a "British management" which many French shareholders blame for the lousy performance of their investment. But it would be entirely Pyrrhic. Or, as the French would put it, fou.

Grade's conflict

Michael Grade says it is "preposterous" to suggest any conflict of interest between his new job as chairman of the BBC and his role as chairman of Pinewood film studios. Others think the conflict is so glaringly obvious that it must be addressed. Although the BBC will not disclose any hard figures, Pinewood earns money from the BBC by filming programmes, among them The Weakest Link. How someone can be chairman of the two organisations at one and the same time therefore beggars belief.

In Mr Grade's defence, it is argued that Pinewood is personal to him in a way that the other commercial directorships he is giving up (Camelot, Scottish Media Group) are not. It was, after all, Mr Grade who led the management buy-in of Pinewood along with 3i and masterminded the subsequent takeover of Shepperton Studios. This, however, only re-inforces the argument for separating the two jobs.

Luckily, there is a perfect opportunity. Mr Grade should use this summer's planned flotation of Pinewood to resign as chairman and place his 5 per cent shareholding in a blind trust, as both the Liberal Democrats and now a Labour member of the Commons Culture, Media and Sports Select Committee have demanded.

Until he does so, it is a weak link to be exploited by his critics.

m.harrison@independent.co.uk

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