King is trumped

Confusing signals have come from Bank of England Governor Mervyn King. Don’t worry. We are all confused and it is actually reassuring that King recognises how difficult the situation is.

First, let’s deal with the easy bit. The Bank’s quarterly inflation report reckons it will take a couple of years for the UK economy to get back to where it was before the recession started.

That is fair enough. As I pointed out in a previous column, the accepted definition of coming out of recession, flat or positive growth in just one quarter, rather understates the effects of the downturn. Just ask the thousands of staff who were laid off by the banks this week even as their employers were beginning to turn the corner at last.

Slow growth will drag us up from a deep trough but in a sense recession continues until all the downturn of the past 18 months is recovered.

However, growth is growth and if anything King has probably erred on the side of caution. By the end of this year we will be on the upward path and with a bit of luck we will avoid the dreaded double dip of a second, potentially confidence-busting, bout of recession next year.

As we have learnt with boom and bust, the bigger the boom the bigger the bust but that works the other way round as well. It is cold comfort, but a longer recession now reduces the chances of another setback just as we are climbing out of the pit.

What is more interesting is the prognosis for interest rates and quantitative easing. The implication in the report was that interest rates will rise sooner rather than later and, by extension, that quantitative easing will have run its course when the latest batch of £25 billion is doled out.

The bank said that if interest rates remained at 0.5% and quantitative easing at £200 billion then inflation would top its 2% target within two years. One should not put too much store by all this.

Firstly, two years is a comparatively long time. It is true that changes in interest rates have a delayed reaction but it would be possible to keep them on hold for a year and still be in time to take effect.

Secondly, 2% is a middle rate for inflation, not a ceiling. It does not greatly matter from the bank’s point of view if inflation tops 2% as long as it does not go zooming past. Therefore there is plenty of scope for caution in raising interest rates and the Bank would prefer to go slowly and speed up later rather than overdo an interest rate raise and suffer the embarrassment of a U-turn.

Indeed, the Bank report effectively confirmed this by stating that if rates rose to 1.5% next year and topped 3% in 2011 then inflation would be pushed significantly below the 2% target. We should remember that 1.5% is very low by historic standards and even 3% is not particularly high.

Since it took responsibility for interest rates 12 years ago, the Bank of England has commendably tried to give the markets reasonable guidance on its intentions with interest rates rather than indulge in shock tactics. Signals are often coded--well, someone has to give economic journalists something to write about--but they are there to see.

What has caused confusion in this instance is that King seems to have muddied the waters with remarks he made later in the day. He said he had an open mind about pumping more cash into the economy and that it was too early to assume that the quantitative easing programme was drawing to an end.

Commentators anxious to justify their previous hype have taken this as confirmation that King will get his way on this issue. However, there is no reason to think that the rest of the committee feel the same way. It is clear, as we noted last week, that there is a lack of enthusiasm for going beyond the £200 billion already agreed but not entirely dispensed.

One other point we should note at this stage is that King is likely to become increasingly enigmatic over the coming months. With an election due in less than eight months and a general election campaign already starting up, the governor will not want to be seen rocking the political boat. The inflation report thus counts for more than King’s subsequent pronouncements.

Chocablock
Forget any jokes about a tasty bid or a treat for shareholders--the offer by US food company Kraft will have Cadbury shareholders choking.

Having failed to persuade the Cadbury board to take a bite at its part share, part cash offer, Kraft has gone hostile with an offer that is looking increasingly stale. The terms of 300p cash and 0.2589 Kraft shares are unchanged from the original approach, an approach that was soundly rejected by the Cadbury board.

It is hardly likely that Cadbury shareholders will find them any more appealing as Kraft shares have gone down in value since September when they were first placed on the table. Overall the offer is now worth £9.8 billion compared with £10.2 billion when it was first mooted.

The tactic seems at first sight bizarre, as this bid will most certainly not succeed. However, one has to remember that Kraft was given a deadline by the Takeover Panel to put up or shut up and the offer keeps Kraft’s options open.

The Cadbury board has inevitably rejected the approach again and the company’s shares, up 30% since bid rumours started to circulate in August, slipped back below 750p.

Those with cold feet still have a chance to bank a nice profit but it is surely best to stay in. Kraft will have to put up top side of 800p, preferably with more cash in the equation, to be taken seriously while the fact that Cadbury is now in play will limit the downside in the unlikely event that Kraft gives up without making an effort to win.

Post it note
I am always happy to pass on warnings of scams and I hear that the latest wheeze is to post a card through your door saying that a private delivery company tried to deliver a parcel for you and that you need to contact them on an 0906 number.

My contact tells me that this is a premium rate number and it costs £15 just to connect to it. Just in case you were wondering, there is no parcel.