Comment: Rate hike case gains ground

By This Is Money
Updated: 05:17 EDT, 30 December 2010

One has to admire Monetary Policy Committee member Andrew Sentance for his consistency.

His view that the Bank of England's base rate, currently at 0.5%, needs to rise to combat a consumer price inflation rate of 4% next year, is highly unpopular.

It comes at a time when leading economists, polled by the FT, are predicting a 5-10% further fall in house prices.

At the same time the Halifax, the nation's biggest mortgage lender pre-crash, warns that it is taking ever longer for first time buyers to accumulate a deposit.

Yet Sentance, in his public statements and with his votes for rate increases at the MPC, makes a serious point.

We are now more than two years past the peak of the 2008 financial panic, the economy is growing again and inflation, unfortunately, is proving stubborn.

When measured on the largely ignored but more meaningful retail prices index, inflation is currently running at 4.7%.

With shop prices likely to rise in early 2011, as the administered VAT increase from 17.5% to 20% comes into effect, inflation is not going to subside very quickly.

Moreover, oil prices climbed to a 2010 peak over the holiday period.

At a more technical level we have seen in the United States, for the first time since the crisis, a return to something like normality in the yield curve, with long-term market rates rising steadily over time.

In other words investors are no longer at panic stations even if the Federal Reserve is still cautious about the durability of recovery.

Sentance is not alone in wondering whether it may soon be time to 'normalise' interest rates.

Bank insider Paul Fisher has noted the MPC needs 'to trigger the mind-set in people that rates will eventually go back up'.

The case against this is the informal undertaking made by Bank of England Governor Mervyn King that he will do his best to let monetary policy take the strain while the government squeezes fiscal policy.

Nevertheless, there is increasing queasiness about the path of inflation and Sentance points out in his post-Christmas broadcast that higher rates would help to protect 'savers from the effects of higher inflation'.

It is too often forgotten that there are seven times as many savings accounts in Britain as there are mortgage borrowers. Sentance has been regarded as an outlier in his views for some time.

But what he is saying now is starting to gain some traction.

Unfulfilled desire

When the Coalition revealed that, as part of its fiscal cuts, the Ark Royal would be retired and Britain would be without a carrier force for the next few years, there was much gnashing of teeth in the defence establishment.

Among the more robust criticisms was that if Argentina, in deep financial trouble, tried some funny stuff in and around the Falklands, or sought to take control of drillings in the South Atlantic by UK oil explorers, Britain would have no means of defending vital strategic interests.

Predicting what Buenos Aires might do is tricky enough for investors hoping to cash in on a new oil frontier.

But it is made even worse when the explorers over promise.

Desire Petroleum does not inspire confidence.

The group's AIM-listed shares soared in early December when the company confidently announced it had found hydrocarbons near the Falklands.

But just 96 hours later it admitted the oil was actually water and it has had to plug the find, sending the shares plunging.

In its latest disclosure Desire admits that its Jacinta Prospect in the North Falklands has also turned out to be a dud, so it is going to have to drill deeper. As a result the shares have taken another 30% hit.

If this goes on for much longer Desire will need a carrier task force to protect it from the Financial Services Authority and angry investors and Britain could invite Argentina to put Desire, Falkland Oil & Gas and Rockhopper permanently out of business.

BRICS reborn

Economists at Goldman Sachs may have laid claim to having invented the concept of the BRIC economies group in 2001 - Brazil, Russia, India and China.

But it is Beijing which is setting the pace in taking the idea forward.

The Chinese government has invited South Africa to join this exclusive high growth club, which could lead it to become known as BRICS or possibly BRICSA.

South Africa is delighted to be included.

But it has a bit of catching up to do with a growth rate of 3% in 2010 against breakneck expansion rates of 10.5% in China, 7.5% in Brazil, and 9.7% in India.