No time for half measures

Mervyn King would have enjoyed yesterday's announcement that interest rates were going up. Not because the deputy governor of the Bank of England takes a sadistic delight in seeing the cost of mortgages and overdrafts rise but because he has long held that monetary policy should be as boring and predictable as possible. Yesterday's move was as boring and predictable as they come. So, for that matter, was the reaction to the decision, which was condemned by the usual suspects for putting the economy on the road to ruin.

But even a moment's reflection would indicate that the Bank had little choice. It was right to put up rates and it was right to put them up modestly. Of course, there is an argument for leaving borrowing costs at 5.5% and there is an argument for banging them up by half a point, but neither is specially convincing. Britain's multi-speed economy, with strong regional differences and disparities between the performance of manufacturing and services requires sensitive handling but there is no doubt that the recent evidence has pointed to inflationary pressure building up.

To take one example: the Halifax yesterday reported that house prices rose by 3.4% in the final quarter of 1999 and by 11.5% for the year as a whole. In Greater London, however, they were up by a stonking 28.9% last year, a faster rate of increase than in 1988, the height of the Lawson boom. The south-east has its own peculiar economic characteristics but house prices generally are being underpinned by the tightness of the labour market, where recent months have seen average earnings rise by 4.9%.

As Michael Saunders of Salomon Smith Barney Citibank put it yesterday, real interest rates are running at around 3.75%, in line with the average of the past five years. But this five-year period has seen domestic demand running well above the economy's long-term potential, despite considerable fiscal tightening. As such, real interest rates of 3.75%, although high by global standards, might not be enough to keep the lid on demand. Put another way, says Mr Saunders, Britain is different. "If both the UK and Germany have nominal short rates of 5.5% and the same inflation rate (say, about 2%), then German households probably would buy bonds whereas UK households would go to the nearest estate agent, borrow lots of money, buy houses and set a house price boom in motion."

So, if the housing market is flashing red and the labour market is flashing amber, why not even more Draconian action? If young internet entrepreneurs are becoming stock market millionaires overnight and spending their riches on palaces and Porsches, shouldn't the MPC stop pussy-footing around with quarter-point increases? Well, no.

The other side of the new economy was revealed when Dixons said this week that its profits are being hit by tumbling prices. Dixons is by no means a one-off. The clothing manufacturer Dewhirst announced yesterday that the squeeze on profits was to blame for the loss of 1000 jobs at two plants in the north, in County Durham and Cheshire. Global overcapacity, an unfavourable exchange rate and ingrained customer resistance to paying higher prices mean that the corporate sector is already being squeezed and could be hit hard by an over-aggressive monetary policy. So, too, could consumers, despite the low level of unemployment.

Geoff Dicks of Greenwich NatWest points out that the personal savings ratio is already at a 10-year-low and might start to rise over the coming months as interest rates edge upward and mortgage interest relief is phased out. Whatever happens, consumers are likely to be as eager to spot a bargain as they have been for most of the past 10 years, providing no respite for retailers.

The money markets are in no mood for any of this, and have convinced themselves that rates are inexorably heading for 7.5% or even higher. But longer-term money market rates are normally wrong, and it may be that the two or three quarter-point rises the MPC has in store for us in the first half of this year will be enough.

Anxious times


Last year was another tough one for Fii Group, the shoemaker which has been struggling to make money for as long as anyone can remember. A serious restructuring had to be completed, including the sale of its business supplying Marks & Spencer. But it found a deficit on its pension fund and in the middle of last month out came the obligatory profits warning.

So it has decided to diversify and is exploring "the new Wireless Application Protocol m-commerce arena". This is not a spoof. Shares in Fii doubled to 120p yesterday.

Taken with the transformation of Blakes Clothing into e-xentric the advice to investors is clear: don't bet on companies which are simply losing money, buy shares in those that are threatening to go bust instead.