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Deer prudence

Central banks are not there to give stockmarket traders a free ride and last week’s decision by the Fed to pause its rate-raising programme did little to reassure investors. We should not be surprised. Ben Bernanke’s team are very cognisant of the inflationary pressures that are swirling around the global economy and it would be extremely foolish to ignore their potential impact. However, the same team seem quite politically aware and I wonder if they are more interested in keeping growth going at the expense of inflation. This has meant that the Americans are having to listen to a new term to them – but sadly one more familiar to those of us of a certain age in the UK – stagflation.

This is an insidious problem to deal with, owing to the rather intractable position it creates within an economy. Stagflation is a mixture of a slowing or stagnating economy which still has embedded inflationary pressures within it. The economic anguish it causes relates to the inability of companies to manage costs in a period of falling demand along with rising costs and a weakening economy for the consumer.

How can the US administration try to address this? It is to be hoped that if the US economy is to continue its slowing process, then some of the inflationary pressures from oil and other base costs will ease as demand falls. However, if the inflation trend starts to transmute into domestic pay costs, it could become embedded and maybe that is just beginning to appear.

The decision to pause on rates was interesting as it implies that there is concern over the downside risks on growth, especially as indicated by the weakening housing market and its effect on consumer confidence.

If the Fed is being political, then our monetary policy committee was certainly trying to be forthright with its views last week. Mervyn King knows the dangers of being too opinionated on issues such as house prices but the message from the Bank of England inflation report was quite clear – there is a 50/50 chance of inflation rising to over 3 per cent in the next six months and, remember, if inflation goes beyond 3.1 per cent, then the governor has to write a letter of explanation to the Chancellor and what he is planning to do about it. The result of this is that the market now clearly anticipates a further UK interest rate rise but probably not until late this year or even early 2007. But a lot can happen in that time, especially if the economy does slow down significantly. Again, the spectre of the inflatable deer will haunt the minds of these central bankers.

Justin Urquhart Stewart is director at Seven Investment Management

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