Michael Harrison's Outlook: Fletcher steers course through choppy waters

Tricky stuff to handle, water. Politically, that is. Too big a price rise and voters could go off the deep end next April just as Tony Blair gets to the polls. Too small an increase and raw sewage might begin to back up all over New Labour as well as the home furnishings.

There is still an outside chance that ministers will stick their oar into the draft price limits announced yesterday by the water regulator Philip Fletcher before he finalises them in December and bills start to drop on to doormats next April. But on balance, Fletch looks to have played his hand with a consummate politician's touch.

How else to explain a set of price increases that kept customers, investors and the environmental lobby all broadly happy at the same time. The industry asks for a 29 per cent rise in bills over five years. It gets 13 per cent. The Environment Agency wants £21bn sunk into capital expenditure programmes to stop sewer flooding and the like. It gets less than £16bn. And yet, water company shares rise across the board, the environmentalists get 94 per cent of their wish list granted and the consumer lobby says customers have done better than expected. Make sense of that.

In truth, water price reviews are as much about managing expectations as giant capital investment programmes. Fletch began the softening up process two years ago by telling customers they could expect significantly bigger bills from 2005 onwards after his predecessor had squeezed the industry dry of cost savings last time around.

Whenever a City analyst suggested, however, that this meant a "benign" outcome for the industry, the regulator fired off a warning shot. As a consequence, a 13 per cent increase in bills is being seen as a good result by customers and investors alike.

Five years from now, a daily water supply will still cost Londoners less than a daily paper. So perhaps it should for a commodity which falls free from the sky. But a torrent of legislation, most of it pouring from Brussels, has made the job of delivering the stuff and then dealing with the effluent which comes out the other end, very expensive.

Even so, after 15 years of price control, the regulator has decided the industry has the scope to find extra savings and deliver more for less. Some water companies have been squeezed harder than others, for instance United Utilities. The supplier for north-west England originally put in for a 71 per cent increase in bills but only got approval for 17 per cent. Perhaps it thought there had been a misprint.

But even for the likes of UU there is a silver lining in these five-year price reviews. Tucked away inside the regulator's 230-page document is a section called "dealing with uncertainties". This boils down to a list of reasons for going back to Ofwat once a year and asking permission for further price ncreases. Apart from the usual excuses such as bad debts and higher than expected take-up of water meters, the regulator has also "parked" £2bn worth of environmental schemes which consumers may end up paying for between now and 2010.

So the headline increase in bills next April is kept low enough not to upset the voters. But the drip drip of extra price rises means the industry gets what it wants, as does the environment. With a bit of luck, customers don't notice bills going up but even if they do there is no one to punish. Perhaps Mr Fletcher is in the wrong profession.

Loan sharks

The last time the Bank of England's base rate stood at 4.75 per cent was on 18 September 2001, a week after two hijacked planes had been flown into the Twin Towers. By comparison, the average standard variable rate charged by the UK's top 15 mortgage lenders was 6.28 per cent, according to a fascinating little table compiled by the estate agents Savills. Assuming that the mortgage lenders pass on yesterday's quarter-point increase in rates (and Abbey already has) then the average standard variable rate will rise to 6.55 per cent - some 0.3 of a percentage point higher than it was three years ago, even though the Bank rate is the same.

Back then, UK base rates were going down as part of a co-ordinated effort to head off a global recession. For the past 10 months they have been going up to take the steam out of a consumer boom. What Savills' figures suggest is that lenders were slower to cut rates than they have been in putting them up.

No wonder this has been a bumper reporting season for the banks, as Barclays demonstrated yesterday with a record £2.4bn profit in the first six months. And no wonder parallels are beginning to be drawn between the profitability of the banks and the £1 trillion of debt that UK households are now carrying.

The banks, of course, will argue, that lending to the retail market is only part of the story and that the real profit growth has come from the recovery in capital markets and overseas acquisitions. This is true. But Barclaycard still made an 11 per cent bigger profit in the first half of this year than last year.

The advantage from the Bank's point of view of high levels of consumer debt is that it requires smaller adjustments on the tiller to produce the required change in behaviour. Hence yesterday's decision, correctly, to resist calls for a half-point increase in rates. The tone of the Bank's statement, with its references to an easing in the housing market and a moderation in consumer growth, also suggests that a further quarter-point rate rise next month is less likely than it was. The Bank might like to engineer a slowdown is house price rises but it doesn't want them to grind to a halt. For that reason, the mortgage lenders should wait to see what happens to rates next month before pushing up the costs of home loans so enthusiastically.

Virgin expansion

If 11 September is a long time ago for monetary policy makers then it is a bygone age as far as the airline industry is concerned. In the aftermath of those attacks, some very senior colleagues of Sir Richard Branson seriously feared it was curtains for his long-haul airline Virgin Atlantic. In desperation, it slashed its flying programme and laid off 1,200 staff. Barely three years later, and Sir Richard has placed the biggest aircraft order by some way in the airline's history for up to 26 Airbus A340 jets.

The $5.5bn price-tag put on the deal can be taken with a lorry load of salt. No airline pays list price, especially when dealing with Airbus, and options make it half the order. Nor is it clear whether Virgin has actually paid any deposits or simply agreed to acquire the aircraft.

Nevertheless, it is an immensely important moment in the airline's history. Together with the Airbus aircraft that Virgin already had on order, including its super-jumbo, the A380, the size of the fleet will grow by 100 per cent over the next five years. That, in turn, will enable the airline to double in size to 8 million passengers and take on an extra 6,000 front-line staff over the remainder of this decade. Then, it really will begin to give British Airways a run for its money at Heathrow.

m.harrison@independent.co.uk