Horns of a dilema

Posted on 10 Apr 2008 by The Manufacturer

Last month’s quarter per cent cut gets a mixed response from industrialists, but as Colin Chinery reports, it is not only interest rates that are worrying manufacturers

I nterest rate is down to 5.25 per cent and there is another quarter point fall within sight. Good news for manufacturing, but Bank of England governor Mervyn King is fighting on the push-pull of two fronts and everyone knows his dilemma: will the rate cut recessionary brake fluid spill over and become the oil that fires rising inflation?
Last month’s CPI showed inflation at 2.2 per cent, almost in line with the Bank of England’s two per cent goal – for now that is. But higher
prices for food and imports and the next wave of energy price hikes are set to push the CPI rate higher, says King.
Last April he had to write a letter of explanation to the then Chancellor Gordon Brown explaining why inf lation had breached the
three per cent upper limit. Now, he is warning it is odds on, he will be penning his successor, Alistair Darling.
But with all the indicators showing a greater than expected slow down in manufacturing, the EEF welcomes the latest cut in interest rates. In
particular it believes the looming chance of a recession in the United States, the credit crunch impact on business and consumer confidence,
and a possible slump in the housing market, outweighs potential risks to the inflation target.
“The evidence from the past month points to a growing risk of a weaker economy. While the Bank is right to keep one eye on inflationary pressures, business will welcome the current measured and gradual approach to reducing rates,” says EEF chief economist Steve Radley.
Everyone acknowledges the Bank’s Janus-like stance. “If you look at what it is tasked to do – keep the rate of inflation down – it would probably have adopted a slightly different tone, and with a lot of inflationary pressures coming through in the economy, interest rates would have gone up,” says David Workman, director general of the glass manufacturers’ confederation, British Glass.
“But the overriding issue now is the fear of recession. And if the Bank had pushed interest rates up a signal would have been sent out that
things were going to get tighter and a recession much more likely. A quarter of one per cent is not going to make much difference one way or the other, to industry or to consumption, and my view is it needs to be a far greater percentage. At the end of the day our sector’s products are consumer products, and if the consumer stops spending it’s going to rebound on us at some stage in the future.
We would like to see measures that would stimulate consumer spending, and this means bolder rate cuts in the future,” – a scenario discounted by economist Ross Walker of Royal Bank of Scotland
financial markets. “I think another cut is coming. Mervyn King
said recently that current rates were bearing down on demand and this seemed to signal some modest reductions. We will probably get another, perhaps to five per cent by May, possibly April.
But beyond that it becomes trickier. Short term inflation will be above target and rising, sterling has seen a significant deprecation over the last quarter, seven per cent lower trade-weighted, and both expectations and some survey evidence on pricing is a little bit too high for comfort. So I don’t think the Bank of England is going to be able to cut aggressively short term.”
But David Kern, economic advisor to the British Chamber of Commerce – which wanted a straight cut to five per cent – wants boldness, arguing that the threats to growth are now “much more acute than the risks of higher inflation,” a view backed by Peter Matthews, managing director of Black Country Metals of Stourbridge.
As president both of the Midlands World Trade Forum and the Black Country Chamber of Commerce, Matthews has the measure of the
regional pulse. “Speaking on behalf of the Midlands international trade manufacturing sector with more than 700 members with exports worth over £2 billion I can say we are all of one mind, all at one point. The MPC have been very timid, and the problem we have with it is that every one of them is an economist, there’s no practical manufacturers
there; nobody that understands the pain of the manufacturing sector. They are not taking into consideration the strength of the pound
caused by high interest rates and the impact on imports and exports. We’ve got to be punchier and show the world that as well as looking
after our currency we are also looking after our domestic manufacturing sector.”
China is the major market for BSA Machine Tools, Kitts Green, Birmingham, and with the Yuan linked to the falling US dollar, an increasingly difficult target for British exporters, says managing director Steve Brittan. “The interest rate has always been a blunt instrument, and trying to keep inf lation down using just this
approach cannot work that simply, and it’s damaging our ability to export. “I have just supplied $1.6 million of kit to Texas for the oil industry. We kicked off with a dollar rate suggesting around $1.75 and when we shipped the machines it was $2 – a massive penalty.
“When the customer requests quotation to reorder he can’t understand why there’s been such a massive price increase, and it comes down to
the strength of the pound, driven by interest rates and the hot money flowing around.”
The US accounts for 15 to 20 per cent of British exports, and for some companies the slowdown there is a major issue. But Ross Walker sees demand in the EU (55 to 60 per cent) holding up and Asia remaining strong. “As long as this remains the case there will still be exporting opportunities, and the lower pound on a trade-weighted basis will help.” The growth of the Far East market is “great for us and the
world economy,” says Roy Ayliffe, director of