KEEPING AN INT Tpounds Rpounds ST IN THE RATE THAT MATTERS; Interest Rates Have Been Left on Hold Again. but What Is the Story Behind That Headline, and What Does the Bank of England Decision Mean on Teesside? Business Editor MIKE HUGHES Reports

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THE thing about finance is that, like a graph of the economy, it has its ups and downs.

Understanding how smaller firms react to interest rate changes means understanding that they are as important to them as they are to the banks and the major corporations. The ripples from a tiny rise or fall spread throughout the region, but there is great danger in the importance of these changes being overlooked.

The family on the high street doesn't care about quantative easing or the minutes of the Bank of England's Monetary Policy Committee. But every shop and business they shop in cares what happens and entire production strategies, forward planning and recruitment plans can change with a few words from Mervyn King.

The chain of events is replayed over and over as the recession grew: * 1. The Bank of England changes its rate. * 2. Individual banks take up that change and make their own national announcements. Sometimes absorbing a change, often passing it on.

* 3. Locally, bank managers do their sums and identify which of their customers will be affected.

* 4. There are awkward conversations between the bank managers with small business owners about new repayment terms.

* 5. Those small firms have to pass on the changes to their customers. Their costs are so tightly-run that there is little chance of doing anything else. Perhaps a short-term 'discount' to hold off the increases and generate a 'winter sale' rush, but then the increase kicks in.

* 6. Customers cut back their own spending because their outgoings have just gone up. * 7. The economy starts to stutter, the Bank and the Chancellor react and we start all over again.

Reaction around Teesside to the latest announcement from the bank was a clear indication of how wide those ripples are spreading.

Alastair Thomson, Dean of the Teesside University Business School gave the background to the economy as it looks now: "Early indications of future trends aren''t very hopeful. The prices of gold, oil and other commodities have started to increase, meaning that many businesses will be looking to raise prices to cover their increased costs. And as businesses increase their prices, people will expect higher wages and salaries to maintain their standard of living, causing more inflation and repeating the cycle.

"Under normal circumstances, the Bank of England would raise interest rates to choke off this future inflation. Scaling rates up and down in response to trends in inflation outlook is the primary weapon in their monetary policy armoury.

"However, by raising interest rates, the Bank also reduces the amount of money in the economy. Crudely, instead of spending the cash in our wage packets on goods and services which can sustain economic growth, we have to give it instead to the banks and building societies to pay our mortgages and keep a roof over our heads. Putting rates up keeps the lid on inflation, but stifles economic growth.

"Right now we are seeing sluggish economic growth as public spending is reined back. Businesses supplying the public sector are seeing contracts cancelled or deferred. And public sector employees are becoming more cautious about spending what they earn and starting to save, rather than spend, more of their wage-packets because they expect some rainy days ahead.

"In short, demand -or at least the share of it provided by the public sector -is already being reduced making it more likely economic growth will suffer, at least in the short term.

John Young, financial director at AV Dawson Limited, based in Middlesbrough is a big backer of Government policy: "The move towards renewable energy, and the major role the North-east will play in this, will require a huge level of private sector investment. The banks will need to play their part to ensure that this investment happens, given the Government support they have received in recent years. …


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