Turmoil may lead to hike in prices

Jan 23 2008 by Tony McDonough, Liverpool Daily Post

Get set for inflation over 3pc, says the Bank of England’s governor, as chaos hits world stock markets. Tony McDonough reports

CONSUMERS are likely to see higher prices for food and energy this year, possibly pushing inflation over 3%, the Bank of England’s Governor said last night.

Mervyn King was speaking after a day of turmoil following the US Federal Reserve’s decision to cut interest rates for the fourth month in a row – this time by a massive three-quarters of a point to 3.5%.

Mr King said the coming year will pose the greatest economic challenges since 1997, predicting economic activity could slow “quite sharply” in the short term as consumers save more income.

In a speech to members of the Institute of Directors in Bristol, he said: “There is a risk that weaker activity and lower asset prices could result in another round of losses for banks and a further tightening of credit conditions.

“It is possible that inflation could rise to the level at which I would need to write an open letter of explanation, possibly more than one, to the Chancellor.”

Mr King must write to Alistair Darling if the rate of inflation goes above 3% or falls below 1%.

The governor accepted there was little that could be done to avoid some rise in inflation in 2008 but said the bank’s Monetary Policy Committee (MPC) was “determined” to keep it below the target of 2% in the medium term.

He also appeared to open the way for an interest rate cut from its present 5.5% when the MPC next meets on February 6 and 7.

Yesterday’s events prompted economic experts and business leaders in Merseyside to admit a UK recession was now a real possibility.

The US rates cut gave the markets a small boost after Monday’s plummet in values but the relief was short-lived.

The gains were not enough to offset Monday’s hefty losses, when the FTSE 100 Index suffered its biggest one-day points drop since the September 11 terrorist attacks in 2001.

The Footsie rose 161.9 points to close at 5740.1, a 3% rise on the day before – Black Monday.

Fears of a US recession left the Footsie 323 points lower on Monday and London's leading share index lost another 239.5 points ahead of the rate cut.

The heightened volatility resulted in a spread of more than 425 points between the Footsie’s high and low points yesterday.

America’s Dow Jones Industrial Average also endured turmoil, reopening after a bank holiday with a fall of more than 450 points at one stage before closing 126.24 down as investors feared the rate cuts may not be enough to head off a recession.

Attention has now turned to whether the UK will follow America’s lead with an emergency cut.

The Bank said earlier yesterday it had no immediate plans to bring forward its scheduled rates meeting.

Banks were among those to benefit the most from yesterday’s rally. Lloyds TSB lifted 9%, while Barclays was 8% ahead. Housebuilders with significant US operations, such as Taylor Wimpey and Barratt Developments, also received a boost from the move to trim US rates, up 6% and 9% respectively.

UNITED States policymakers announced the rate cut to 3.5% before America’s markets opened in a bid to stem losses and stave off a recession.

The Fed had not been expected to cut borrowing costs until the end of the month, but said yesterday’s surprise decision came amid gathering economic gloom.

Paul Williams, an analyst at Liverpool-based stockbrokers Blankstone Sington, said the dramatic rate cut made in the United States sent out a clear signal that the economic crisis facing the world was now worse than was first thought. He added: “The last time the Fed did something like this was in 2001 after the September 11 terrorist attacks.

“On the one hand it sends out a signal, along with the proposed tax cuts, that the US is determined to stimulate the economy. On the other hand it also suggests that things are much morse than we thought.

“Yesterday, just after the rate cut announcement, the FTSE was up around 100 points but it fell back again when people started to realise the message that sent out about the state of the US economy.

“However, I don’t think we will see the kinds of falls in the market again in the next few weeks that we saw on Monday.”

But Mr Williams also said many analysts and traders were now of the opinion a recession on both sides of the Atlantic was now a real possibility. “I think we have now priced in a recession because the signs of it are definitely there,” he said.

Peter Stoney, an honorary fellow at Liverpool University Management School, said he didn’t believe there was an immediate threat of a recession but that much depended on the fortunes of the US economy.

Last week US President George put forward a series of tax cuts, that still need approval by Congress, in an attempt to get American consumers spending and thereby boosting the economy.

The Liverpool Research Group in Macroeconomics, of which Mr Stoney is a member, believes the Bank of England needs to be more proactive and consider another cut in interest rates.

Mr Stoney said: “There is a question mark over just what the package put forward by the President will contain. Until then we won’t be sure. The Liverpool Research Group in Macroeconomics thinks it is unlikely we are facing a recession.

“The Bank of England is dithering this month as it did last month, and making it more likely that the UK will follow suit.

“We thin k that the Monetary Policy Committee is dithering.”

MR STONEY said: “We have been consistently calling for more reductions in the Bank of England interest rate, part of the consequence of not doing so is the nosedive in the UK stock market on Monday.

“There is no prospect of that in the next two or three weeks. There has been no suggestion this week of an emergency meeting of the MPC.

“If things do go pear-shaped in the US and we don’t cut interest rates here we will have to look at tax cuts, but the Labour Government is reluctant because of public sector borrowing and Northern Rock. They need the money to pay off the excessive borrowing.

“What we can do is reduce interest rates, maybe by more than 0.5%. A positive sign is the employment figures, that is quite favourable feature of the current situation. Most of the situation is panic reaction.

“The financial markets don’t reflect the real markets in labour and commodities. Financial markets don’t reflect the actual situation in the UK. The labour market is holding up okay.

“The lever for monetary policy – the interest rate setting – has not been managed because the MPC and Bank of England have dithered. It should stop immediately, but there is no prospect of that happening in the next two or three weeks.”

Liverpool Chamber of Commerce chief executive Jack Stopforth admits a US recession could have a knock-on effect for the UK but hopes Liverpool’s economy is strong enough to survive a downturn.

He said: “As a generality businesses in Liverpool are better placed than most and local economy is stronger than it has been for a long time.

“The current crisis is essen-tially financial in character and if dealt with properly by the Fed and Bank of England, other central banks and the retail banks, then it need not automatically lead to longer-term economic damage.”

BILL GLEESON: PAGE 8

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