Will north pay the price for southern comfort?

THE ANNOUNCEMENT of a quarter point increase in interest rates to 5.5 per cent yesterday was, inevitably, controversial. Although widely expected, the fact that the Monetary Policy Committee(MPC) is known to be divided about inflation prospects gave critics of the decision fresh confidence.

Many said it would widen the North-south divide, forcing industry to pay the price for the excesses of metropolitan consumers.

Martin Temple, the director general of the Engineering Employers' Federation, said: "The decision will continue to penalise disproportionately the manufacturing sector." The high exchange rate of the pound means manufacturers have struggled to export for most of the past two years.

Stephen Alambritis, spokesman for the Federation of Small Businesses, described it as a "woeful" decision, adding: "The MPC is preoccupied with London and the South-east. This is being used as a blunt instrument to calm down consumer demand."

Roger Lyons, the general secretary of the MSF union, agreed. "Inflation is still very low despite a boom in the housing market in the south of England," he said. "The voice of manufacturing and the regions are not being heard."

Agriculture has, like much of industry, suffered enormously from the strong pound, which farmers blame on interest rates being well above European levels. Ben Gill, president of the National Farmers' Union said: "I cannot make it plain enough that Britain's exorbitant rates compared to the rest of Europe and the corresponding strength of sterling is perhaps the single greatest contributor to the current farming crisis."

The news earlier this week that average house prices had surged 2.8 per cent last month alone must have helped trigger yesterday's decision by the MPC. Certainly, the biggest one-month rise in prices since the height of the late 1980s housing market bubble reinforced the stereotype of conflict between the needs of serious Northern manufacturers and frivolous Southern cappucino drinkers.

But other indicators have been steadily tilting the balance towards higher interest rates since the previous MPC meeting. The economy grew faster than expected in the July-September quarter and, despite the complaints, manufacturing has also begun to recover.

More alarmingly, pay growth has accelerated during the latest two months for which official figures are available, prompting Gordon Brown to issue repeated warnings about the need to keep the lid on pay claims.

Speaking to the annual Confederation of British Industry (CBI) conference earlier this week, the Chancellor said: "Unacceptably high wage rise will not lead to higher inflation, but to higher interest rates.

"It is in no one's interest if today's pay rises threaten to become tomorrow's mortgage and interest rate rises." Signals like these left many business organisations resigned to yesterday's increase. Kate Barker, the chief economist at the Confederation of British Industry said: "The CBI accepts that there are currently some indications of future inflation pressure."

Two increases in mortgage rates, one in September and another expected in response to yesterday's announcement, are unlikely to dampen the housing market. Michael Coogan, director general of the Council of Mortgage Lenders, said: "The housing market is performing healthily at present and it is unlikely the rise in interest rates will damage the market generally, although it will help dampen down local hotspots."

So there were calls yesterday for the Chancellor to consider moves that would take the pressure off the Bank of England. The EEF said he should look again at stamp duty or other specific measures to tackle overheating in the housing market.

The British Chambers of Commerce (BCC) and the Institute of Directors called for the tax and spending policy to become tougher. "The Chancellor must identify other weapons to combat inflation," said Ian Peters, deputy director general of the BCC. He accepted that the Bank could not use interest rates to target the imbalances between the North and South, but he said there was too much weight being placed on monetary policy, and not enough on fiscal measures, in order to tame consumer demand. Economists, nevertheless, expect more interest rate increases, although not until after the New Year, when any potential Millennium Bug problems have been ironed out.

Ciarn Barr, UK economist at Deutsche Bank said: "Interest rates at 5.5 per cent are still low enough to stimulate the economy.

"We are seeing an artificially low inflation rate because of the strong pound, but import costs are levelling off and goods prices will stop falling,"

However, there is a vigorous debate about whether rates will need to go much higher in an economy in which retailers find it hard to pass on any price increases.

In a recent speech DeAnne Julius, the MPC's most prominent interest rate "dove", suggested that the UK is not prone to the same inflationary tendencies that it from suffered in the past thanks to increased competition and globalisation.

A City report published yesterday raised the new hope that shopping over the Internet might help keep inflation low, perhaps lopping half a percentage point off the inflation rate eventually.

David Owen of investment bank Dresdner Kleinwort Benson said: "We would expect the Internet to have a substantial impact on the inflation figures on a five year view. The trouble is the timing is very uncertain."

The downward effect would be reinforced, he added, by more transparent pricing thanks to the single European currency, which is already having a big impact on the price of goods such as cars.

Meanwhile it is clear that traditional retailers are having to keep prices low. The British Retail Consortium reported yesterday that prices in high street stores were 1.3 per cent lower now than in November 1997, according to its figures. Ann Robinson, the BRC director general, said: "The British shopper continues to receive excellent value for money."

Leading article, Review page 3