Outlook: A tale of two economies

WITH BUMPER City bonuses again this year, if not quite as good as hoped for, and executive pay rises running into double figures, it's no wonder one of the South-east's most chi-chi chains of sandwich shops has just put up its prices. A six per cent rise in the cost of a cup of tea in Canary Wharf this week leaves no room for doubt that the steam is escaping around the edges of at least some parts of the economy.

Unfortunately, the same is not true of manufacturing industry north of Watford. This is why it has become conventional wisdom to argue that the interest rate judgement is finely balanced. On one side of the argument there are booming services, retail sales, and private sector pay settlements. On the other there are depressed export orders, manufacturing gloom and falling producer prices.

For the gloomier pundits in the City, the worsening trend in the trade figures - which should not be obscured by a modest improvement last month - tips the balance in favour of manufacturing and against a further increase in interest rates. But there is one problem with this logic. It is that exports are still growing at a remarkably robust pace.

The trade position is getting worse because imports are growing like topsy, sucked in by their cheapness - thanks to the strong pound - and buoyant consumer demand. This looks ominously like a classic British balance of payments crisis in the making. And it's being caused by an overheating economy, the only obvious difference from the traditional pattern being that some production is still going for export rather than all being diverted to the home market.

In other words, the evidence weighing against another increase in interest rates is not as great as we are supposed to believe. Manufacturers have rarely been so pessimistic, but there is little evidence that business has collapsed because excessive interest rates have squeezed demand dry.

There are two risks the Bank of England's Monetary Policy Committee will be weighing up when it meets next week. To raise rates would be to risk slowing growth to below trend and having to reverse the decision later. The other risk is that of not doing enough to prevent the British economy from running into the same old inflationary difficulties that have plagued it in the past. Its members should try the novel risk of doing a bit too much rather than a lot too little.

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