Net threat to interest rates

Failure by the Bank of England fully to take on board the revolutionary impact of the internet raises the risk of interest rates being set too high to control inflation, one of the bank's leading policymakers said yesterday.

Sushil Wadhwani, who sits on the nine-member monetary policy committee, suggested that the UK authorities could damage growth by continuing to base policy on old rules of thumb about productivity and price rises which may no longer apply.

In his personal view, Mr Wadhwani - who joined the Bank's committee last summer - said there was plenty of evidence to warrant a re-examination of the Bank's working assumption that productivity growth had not risen from its long-term trend rate of 2% a year, even though there was no sign of it in the official data.

His analysis rests in part on likely growth of the high-tech sector, the example set by America, where productivity has soared in recent years, and on the dramatic cost savings being made by companies through shortened supply chains.

Mr Wadhwani said productivity improvements were probably being masked by the costs of adjusting to new technology and measurement problems.

His comments, in a speech last night at the London School of Economics, place him squarely at the dovish end of the spectrum on rates along with DeAnne Julius, although he was one of eight committee members to vote for a quarter point increase to 6% earlier this month.

Mr Wadhwani believes that in the short-term, the disinflationary impact of the internet could easily be more than offset by a housing market bubble. He is also concerned that rapid internet-related corporate investment could have a perverse impact on inflation at a time when demand is already strong.

"The internet has important disinflationary effects without implying the death of inflation," he told the LSE audience.

Mr Wadhwani view put him at odds with Mervyn King, the deputy governor of the Bank of England, who last week dismissed the notion that the internet was transforming the performance of the British economy. However Mr Wadhwani, a former hedge fund manager, who joined the committee last summer, said the stock market's optimism about the potential of the high tech sector may be overstated.

Citing a survey of 133 internet companies carried out last year, he pointed out that the firms would have to expand their revenues by more than 80% per year for the next five years to justify their current market valuations - more than Microsoft, which grew by 53% a year in the first five years, and Dell, which grew by 66%.

He also he thought the Bank was being too conservative in its estimate of extent to which profit margins were being squeezed by the extra competition associated with the net.