Ken and Eddy just can't see eye-to-eye on rates
IT WOULD be the stuff of nightmares for South Africa's financial markets. Just for fun, speculate on the impact of the following headlines: 'Manuel defies Stals', or 'Manuel rebuffs Reserve Bank call for higher rates'.
Considering what happened last year when Manuel declared that financial markets were "amorphous", the effect on domestic and international confidence would probably be seismic in proportion.
Similar headlines in London this week, but with the names of Chancellor of the Exchequer Kenneth Clarke and Governor of the Bank of England Eddy George raised barely a ripple. The pound, which has climbed 16% in the last seven months, barely twitched, even though one of its two main props, the strong price of North Sea oil, is creaking.
Its other support, the highest returns on Treasury bonds among the Group of Seven economies - 7.1% on 10-year gilts against 5.6% on German bonds and 6.4% on US Treasury paper - remains in place even if the expected hoist in short-term interest rates is deferred until after the general election some time in the next three months.
Collisions between the Chancellor and the Governor are not new.
Last year Clarke heeded the Bank's warnings and after cutting the base interest rate to 5.75%, a 30-year low, he marched it back to 6%.
But since then he has dug his heels in at each monthly meeting with the Governor - known as "Ken and Eddy day".
This week's, however, seemed more violent than usual even though the difference between Messrs Clarke and George is a mere 25 basis points. It arose in the Bank's three-monthly inflation report - instituted after Britain was forced out of the European exchange rate mechanism in 1992 to give the Old Lady of Threadneedle Street a higher profile in setting monetary policy.
Once again the report said it felt that inflationary pressures were building two years down the road and a further mild pre-emptive touch on the brakes was needed. The government's medium-term core inflation target is to limit the rise on the consumer price index (excluding the effect of mortgage interest payments) to 2.5%.
And the Bank actually sees it falling below that level - to 2.2% - as the effect of sterling's appreciation works through later this year, which it had yet to do in 1996. Industrial input prices have fallen by more than 2% because of the pound's strength, mainly against the dollar, in which almost all raw materials are priced.
But by the end of the year, this one-off impact will have worn off and other factors will come into play.
These factors range from falling unemployment (to 6.5%, the lowest rate for more than six years), and rising wages, especially in the services, which are up by 4.3%, an increase of 1.2%.
All the Bank wants, according to deputy governor Howard Davies, is a 25 basis points rise to 6,25% - down on the 50 basis points George was suggesting might be needed two months ago.
Its "central projection" is that without such a move, core inflation will be almost 3% by the end of 1998 and heading higher in the following year. The Bank's chief economist, Mervyn King, was adamant on "the need for a moderate tightening of monetary policy".
Clarke would have none of it. Noting that the Bank had downgraded its view on the appropriate base rate, Clarke cheerfully said he saw no need to take action - yet. In fact the rise in the pound is already acting as a drag on industry: British Steel, for example, says it will mean a 50% drop in profits and another rise in interest rates would increase the pain. Some forecasters are saying that increased competition in export markets and at home from imports will see the economy slow to a growth rate of 2.5% from the 3.5% originally expected.
Even though Clarke was not directly accused of pre-election tactics - and at least keeping industry and home buyers on the side of the Conservatives by not raising the cost of money - the latest disagreement has resurrected the issue of de-politicising monetary policy by empowering the Bank of England in the same way as the Bundesbank in Germany.
The Financial Times said the quarterly inflation report was a faulty compromise between making the Bank more independent and allowing the Treasury to retain control of monetary policy. "The Chancellor can wave them aside in a wreath of cigar smoke," says the FT.