Setting inflation targets nobody wants to meet

COMMENT: 'Britain has enjoyed, not a jobless recovery but a voteless recovery. If the Chancellor decides to ignore the Bank's advice it will be because he thinks faster growth and higher inflation will deliver more votes'
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Is the Bank of England crying wolf again over inflation prospects? Kenneth Clarke was clearly right to turn down the Governor's advice to raise rates in May last year because the economy then started slowing down rapidly. Inflation optimists will be behind the Chancellor again if he turns down similar advice at some point during the next few months. After all, even the Bank agrees that inflation is for the moment still on a downward path.

But actually what these optimists are really saying is not that inflation is dead but that a bit more inflation does not matter. The Bank's projection that falling inflation will be followed by rising inflation is uncontroversial. Almost every economic forecast displays the same pattern. To argue that the Bank's boffins are simply programmed to be gloomy is therefore to misinterpret the message.

The Bank of England is condemned to believe that the inflation target is one it is supposed to help the Chancellor meet. The question is whether the Chancellor, and the rest of us, take it quite so seriously.

As Mervyn King, the Bank's chief economist, said yesterday, inflation has been below its target for only 10 out of the past 40 months. British inflation is well below its historical average but remains higher than the EU average. "We've still got a long way to go before we persuade people that we're serious about this," he said. Judging by the reaction of some experts who think that yesterday's warning was sheer overkill, he is surely right.

The issue goes beyond the prospect of a conflict at future Ken and Eddie meetings. Mr George issues the advice that his job requires. The Bank is supposed to say when it thinks interest rates need changing to keep inflation below the 2.5 per cent target set by the Chancellor. Mr Clarke accepts or ignores the advice depending on his own judgement - which is partly a judgement about the state of the economy, partly a political judgement about what the voters want. Britain has enjoyed, not a "jobless" recovery but a voteless recovery. If the Chancellor decides to ignore the Bank's advice it will be because he thinks faster growth and higher inflation will deliver more votes.

As Mr King put it yesterday, "Are we in the UK sufficiently committed to a world of price stability?" The answer must be not yet. The evidence for this is not just with the pundits who say the Bank is guilty of overkill. From differing perspectives, industrialists and workers alike fall into the same trap. Companies still demand an absurdly high hurdle rate of return from investment projects. The underlying pace of wage settlements remains a full percentage point above the inflation target. The reason is obvious - it is that most people do not believe that inflation is dead. And while so many say that a bit more inflation does not matter, who can blame them?

The Bank is not crying wolf. It is perfectly reasonable to forecast that inflation will be above 2.5 per cent in two years. The trouble is that, having set the inflation target, many of us, Mr Clarke included, are not so sure that we really want it.

Kepit signals a trust earthquake

Frogs can be turned into princes - really, they can. The undignified scramble among fund managers for Kepit, the frog-like sounding European privatisation trust run by Kleinwort Benson, looks like proving the point. Launched with splendidly poor timing just two years ago, the trust has proved an unmitigated investment disaster. Now it has no less than six different suitors dancing around promising better performance and a narrowing of the discount that has opened up between the share price and the value of the underlying assets.

Kepit may be a bit of a one-off but it has probably sparked a trend. If the vultures can move in on one poorly performing trust, they can move in on others. It may well be we are about to witness a minor earthquake in the traditionally sleepy world of the investment trusts. So here's our pick of the takeover target pops. With no warrants to act as poison pill, Kleinwort Overseas must look highly vulnerable. So too must the Mercury European Privatisation Trust, a mirror image of Kepit. Its last restructuring failed to have any impact at all on the size of the discount. Scottish Investment Trust, standing on a 14 per cent discount, is tipped by some simply because it is independently managed. As a consequence there is no powerful fund management group to upset with a bid. Throgmorton Trust has proved disastrous in investment terms and looks ripe for the plucking. Perhaps unfairly, for its investment performance has been a reasonable one, RIT Capital Partners trades on an 18 per cent discount - enough to justify a serious restructuring at the very least.

Investment trusts generally have become about as fashionable as C&A tank tops, providing another powerful spur to consolidation. Outside highly specialised vehicles such as those investing in the boom markets of eastern Europe, it is hard to launch any kind of new trust these days, if for no other reason than that the cost of doing so means the investor automatically and immediately loses about 4 per cent of his money. So fund managers must look to the established trusts of their rivals to grow their income. A shakeout is long overdue in any event.

Commuters beware of French bearing gifts

A certain sense of deja vu must have swept through the Department of Transport yesterday at the news that a French water company is to take over another of our train franchises. The dismantling and sale of British Rail is starting to bear a distinct resemblance to the privatisation of the bus industry in the early 1980s.

Initially there were 70 separate bus companies. Now nearly half of them are under the control of just two groups. Likewise, as fast as ministers break up the rail industry, private sector bidders appear intent on putting it back together again. Compagnie Generale des Eaux, through its quaintly English-sounding rail subsidiary, London and South Coast, has become the proud owner of two commuter franchises - Network South Central, which it already operates, and now South Eastern.

The concentration does not stop there. The coach operator National Express has also bagged two of the 25 franchises and Stagecoach, which already runs South West Trains, is bidding for the 12 franchises yet to be offered for sale not to mention a train leasing business.

More consolidation is certain to come. So much for the brave new world of rail competition that was one of the justifications for privatisation.

Compagnie Generale des Eaux may be promising brand new trains for long suffering commuters into Charing Cross. But ministers should be wary when the French come bearing gifts. The experience of the bus industry proved that while consolidation can bring efficiencies, it is also a recipe for rampant abuse of market power.

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