Growing chance of rate cut

THE Bank of England has set the scene for a cut in interest rates. Deputy Governor Mervyn King said in the quarterly inflation report that the 20% plunge in share prices since May had prompted the Bank to lower its forecasts for price rises and growth.

Inflation is forecast to rise to above 2% by the end of the year, and then drift up to the 2.5% target.

Ominously, King identifies Gordon Brown's £7bn National Insurance grab as the biggest single risk to price stability. It could force up wage bills if workers demand more pay to make good the shortfall in their take-home cash.

That aside, the report reinforced the feeling in the market that a rate reduction may be on the cards, particularly if America's Federal Reserve cuts US rates next week in response to fears of a deadly 'double-dip' recession.

The Bank has for some time been attempting a balancing act between struggling manufacturers, who would benefit from low rates, and buoyant consumers and homebuyers, whose propensity for borrowing needs to be kept under control.

Manufacturers are often used to justify rate cuts. But the inflation report reveals that, perversely from the policymakers' viewpoint, the metal-bashers have reacted to lower rates by paying back their debts and not by investing.

The jury is still out on whether the nasty fall in manufacturing output in June was a one- off caused by the Jubilee and the World Cup, or an augury of something more sinister.

But while industry is stubbornly refusing to borrow, consumers and homebuyers are all too keen. Total credit to households rose by 12.5% in the year to June, the highest growth rate for more than ten years, taking the ratio of household debt to income to an all-time high. Worryingly, the report reveals it is poorer families wanting to get onto the mortgage ladder who are borrowing the most.

The sanguine King appears to think this is quite a good thing. Hard-up households, he says, can now obtain home loans more easily, and will find the debts easier to service as their incomes rise. Unfortunately, he seems to have forgotten that many of the poor do not get big pay rises - they stay poor. These families will be among the most vulnerable to a rise in rates.

King, who views terms like housing bubble as 'unhelpful', does not expect prices to fall but believes that the runaway rate of increase will slow to 3 to 4%.

He suggests that low rates and low inflation, along with a shortage of supply, might sustain home values at a higher level than their historic average. Let's hope so. Buoyant house prices are cushioningthe effect of falling share valueson consumer confidence, and a severe downturn in housing could be disastrous.

Right, said Fred

ROYAL Bank of Scotland has barely put a foot wrong since its controversial takeover of NatWest. Whilst the other big four banks reported stagnant profits, RBS chief executive Fred 'The Shred' Goodwin, delivered his usual recital of strong income growth and improvements in efficiency. Profits in the six months to June rose 15% to £3.15bn, with dividends up 15% to 12.7p.

Goodwin's secret formula for generating revenue growth without increasing risk is that much of RBS's income does not come from loans, but from other sources such as its Direct Line insurance subsidiary, where profits soared by 37% to 153m.

Fortunately for customers, Goodwin has delivered superior profits without emulating Sir Keith Whitson, the cheese-paring boss of HSBC, who is re-routing British business banking calls to phone centres in India.

The one possible cloud from the NatWest acquisition might be a need to top up its pension fund. That was one worry that clipped the shares 87p to 1443p. Others were property exposure and fears that the bank's Spanish chum, Banco Santander, which is heavily exposed to troubled Latin American economies, is planning to offload its 9% stake. Santander dismissed the talk.

Provisions for bad debt were lower than expected, but were still hiked from £369m last year to £652m. The integration of NatWest is ahead of Goodwin's initial timetable and on track to meet new, tougher targets introduced last year. That frees Goodwin to look at what he calls 'mercy killing' takeover bids in the UK, though he says he is keener on more acquisitions in America, where the integration of recent purchase, Mellon Bank, is also ahead of schedule. The acquisitive Goodwin may not be the most cuddly figure on the financial scene, but he is certainly one of the most efficient.