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Britain: A Fight To Stop Services From Stoking Inflation

Business Outlook: BRITAIN


For months, the dichotomy between the unyielding strength in services and construction and the growing weakness in manufacturing has stymied economists and policymakers concerned about the inflation outlook. Now, data are starting to suggest that a broader slowdown is developing. But the crucial question remains: Is the economy slowing enough to quell rising inflation pressures?

First off, slower growth seems inevitable, if only because of current policy. Going into its Apr. 8-9 meeting, the Bank of England's Monetary Policy Committee (MPC) had lifted the base rate by 1 1/2 points in 1 1/2 years, to 7 1/4%. The MPC says growth must fall below its long-term trend of about 2.5% to assure that price pressures subside. Also, fiscal policy is still a drag--though the 1998-99 budget lessens the weight--and new tax hikes are now hitting consumers. Plus, the trade-weighted pound has surged some 30% in the past year and a half, recently reaching a nine-year high vs. the German mark. That spike partly reflects concerns over Europe's single currency, the euro.

Sterling's strength has hammered manufacturers who export, putting the factory sector on the brink of recession (chart). Manufacturing output fell in the fourth quarter, and unexpected weakness in January and February may yield a first-quarter decline. The latest survey of purchasing managers suggests continued strength in services, but domestic demand may be cooling. Official data on retail sales through February show a slower pace of buying vs. the fourth quarter, and the Confederation of British Industry reported a "marked" weakness in March retail sales.

The problem is that both wage and price pressure, while absent in manufacturing, is already visible in services. Underlying inflation--less mortgage costs--has been above the MPC's 2.5% target for two years, even given sterling's surge. Some on the MPC are worried that unless the economy slows considerably, the overvalued pound's eventual decline will only add to inflationary pressures.BY JAMES C. COOPER & KATHLEEN MADIGANReturn to top

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