Forget the d-word but still cut rates

Deflation is the word of the moment. Across the developed world, it is trendy to say that almost every nation is at risk of becoming the new Japan, with reflationary policies rendered futile by falling prices. Inflation? That's last year's thing.

DeAnne Julius, once arch-dove of the Bank of England's monetary policy committee, is the latest guru to point up the dangers of deflation. Her old colleagues should take a few more risks with interest rates to prevent underlying inflation - now 1.9% - falling even further below its 2.5% target. Figures out yesterday for factory gate prices support her argument; there is scant evidence of inflationary pressure at the start of the production chain.

That said, Ms Julius is right for the wrong reasons. There is a case for the MPC cutting rates, but not because of any imminent threat of deflation. Prices of goods in the UK have been falling for four years, but inflation has remained positive because of price increases in the service sector. The two phenomena are linked; cheaper prices for audiovisual equipment or microwaves give consumers more money to spend on eating out or holidays and, given that the vast bulk of the service sector is sheltered from overseas competition, stronger demand translates into higher prices.

There are other factors at work as well. As Mark Miller of Morgan Stanley pointed out, the strength of the housing market, coupled with council tax increases of 8% and the "stickiness" of rents and transport costs means there is a substantial bulwark against service sector deflation. Without a crash in the housing market coupled with a sustained rise in unemployment, it is hard to see the service sector being hit so hard that prices in the economy overall will fall. But the MPC does not have to wait for deflation before acting; its mandate is to keep inflation at 2.5%, something it has persistently failed to do. Given the global outlook, it is clear that the risks of inflation are on the downside, even if deflation does not yet beckon.

Trouble in store


Somerfield has had its fair share of corporate reputations over the years. From the hopelessly over-leveraged management buyout of the late 1980s, through the bungled merger with Kwik Save and on to the farcical events of recent days, it would be easy to conclude that the business is in some way jinxed.

Yet the announcement yesterday still managed to take the breath away. Against market expectations of £40m or so in profits this year, the business will see no improvement on the £22m produced last year. This is a tacit admission that the two-and-a-half year recovery programme put in place by executive chairman John von Spreckelsen and chief executive Alan Smith has failed. Kwik Save is still being squeezed by its bigger rivals, while shoppers are leery of using the regular, badly sited Somerfield stores despite an extensive refit.

So Mr Smith has resigned and Mr von Spreckelsen is left holding the pieces. Presumably, his job now will be to find someone foolish enough to take over the business.

This is not why the shares collapsed yesterday. What has rankled with investors is that they feel they have been misled. Last week Somerfield parted company with its finance director, Martin Gatto. Whenever a company loses its finance director, big investors ask whether something has gone wrong with the numbers. In the case of Somerfield, the answer last week appears to have been an emphatic "No!"

So in the space of a few days the company's profitability has all but halved - and now the share price has as well.

Logic dictates that a shortfall of this magnitude cannot have been caused by "lower market growth and material deflationary pressure", as the company said yesterday. Bad management is a much more likely cause, and the question now is whether the company delayed announcing the bad news.

A formal who-knew-what-and-when inquiry looks inevitable.

Power surge


The evangelical pursuit of a fair and transparent market in electricity is threatening to end in a full blown energy crisis. It may sound alarmist to talk of California-style power blackouts and rocketing prices, but the risk is real.

British Energy, which produces about a fifth of Britain's juice, is bust and only continues to operate because it is underpinned with government money.

TXU, the American operator, has admitted that its British operations are unsustainable. Powergen cut its generating capacity by a quarter last week.

Peak winter demand for electricity is said to be just over 50,000 megawatts. Until recently capacity stood at about 70,000 - allowing a healthy safety margin to cover spikes in demand, while at the same time sending prices tumbling under Neta, the new electricity trading arrangements.

That generating margin (call it overcapacity) is disappearing. If and when it does, those who designed the Neta system will learn that prices can go up as well as down.