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The Bank of England has had a torrid time of late, with inflation persistently overshooting its forecasts and a series of letters to the Treasury to explain why this has been the case. Independent analysis shows that nominal spending in the UK is rising and inflation has hit four percent. Cries can be heard from the City – particularly from investors concerned with the value of their bond portfolios – that the bank is losing its inflation-fighting credibility and prices are slipping out of control.

Such fears are overdone. The bank has correctly pointed out that a string of one-off factors – VAT rises and commodity price shocks – have pushed inflation up. Strip these out and we see that core inflation is closer to two percent. What is more, with so much spare capacity in the economy (unemployment remains at 7.9 percent); there is little reason to expect core inflation to rise.

None of the side-effects of core inflationary pressure are yet in evidence. When wages do not keep pace with inflation, firms get a greater share of earnings and they can employ more staff, causing unemployment to fall. But there is little sign of such forces exerting a strong pressure to close the employment gap. Rising employment and increased core inflationary pressure would also, if they were taking place, lead to higher output. But UK GDP actually contracted by 0.5 percent in the fourth quarter of 2010. This was partly due to snow, and may be partly made up in the first quarter of 2011 as economic activity is displaced across time, but the UK seems to have fared worse than the US, Germany or France – suggesting that the tendency in Britain is still for the output gap to widen.

Admittedly, the available spare capacity in the UK economy may be less than is commonly assumed as frictions and uncertainty prevent firms from hiring new workers. This would cause the effects of nominal spending increases to be tilted towards inflation and away from output growth. But, with official unemployment sitting at three percent above trend and actual unemployment probably higher than official statistics detect, it is hard to believe that spare capacity is zero or anything like it.

Even if elevated core inflation were more likely than my analysis suggests, a brief period of above-trend inflation could actually be good for the economy, and for laid-off workers, if it eroded real wages, making it possible to get people back into work. It could also permit real house prices to fall without precipitating another recession and could soften the paralysing effects of debt. This latter would he hard on creditors, but it would not cause financial-sector distress (unless it was followed by a sharp interest-rate shock) as the value of bank liabilities would be eroded alongside their assets.

It may be that the commodity price shocks of the past twelve months will prove to be anything but temporary and will be repeated many times as we experience a combination of increased global demand, depletion of the cheapest resources and supply disruptions arising from floods, storms and other effects of global warming. In this case, a permanently tighter monetary stance would be needed to prevent persistently high inflation, with its corrosive effects on real investment and growth. But, while environmental stress will undoubtedly affect the economy in the years and decades ahead, it is far from clear that it will immediately cause inflation to rise and, when it does, central banks will have plenty of time to act, without premature tightening now.

Over the next few years, harsh and prolonged fiscal tightening will tend to keep a lid on core inflation. There is thus no case for a sharp monetary tightening. Interest rates should be increased slightly, but only because monetary policy is currently on its loosest setting in the bank’s 300-year history. Such monetary ease was necessary in late 2008 and early 2009 when the financial system was on the verge of collapse, but it is now excessive and should be unwound. However, even as it tightens marginally, the bank should stand ready to reverse course if employment and output decline again.

Asia runs the risk of being left behind in the sudden wave of transatlantic stock exchange consolidation, given the tough regulatory regimes, cumbersome ownership structures and protectionist minded governments.

The proposed tie-up between NYSE Euronext and Deutsche Boerse along with the London Stock Exchange’s move for Canada’s TMX Group has prompted talk the global exchange market is set to shrink to two or three big players. But a reluctance by many Asian nations to cede control to foreign ownership and the struggle to improve capital market integration means their exchanges are unlikely to have a seat at the table.

“I just don’t think they’re ready for consolidation – all of the deals aside from ASX-SGX are happening on a transatlantic basis, in the places where people have felt competitive pressure with costs coming down and electronic trading gone up,” said London-based Niki Beattie, managing director of trading consultancy Market Structure.

“Asia just hasn’t got to the point yet where it’s feeling that pressure.”

Singapore Exchange kicked off the latest round with a $7.9bn bid for the Australia stock exchange operator ASX Ltd late last year.

On the surface, the logic for more deals in Asia is compelling.

Asia is home to the Hong Kong Exchanges and Clearing Ltd , the world’s most valuable stock exchange operator, valued at $23bn. HKEx may knock on the doors of the tech-heavy Nasdaq or Chicago’s CBOE as it eyes a partner amid a frenzy of merger activity.

Share turnover volume in Asia-Pacific rose five percent in 2010 to hit $19trn while turnover in the Americas fell 0.8 percent to $33trn according to the World Federation of Exchanges.

In terms of new listings, Asia-Pacific bourses attracted nearly 22,000 new firms last year, up three percent on 2009. That came as Europe, the Middle East and Africa saw their listing volume slide two percent to just under 14,000 and America saw a 0.3 percent drop to just over 10,000.

But potential suitors keen to get a slice of this growth are likely to run-up against ownership structures prohibitive to foreign investors.

Several Asian bourses such as the Bombay Stock Exchange limit the proportion of equity that can be held by a single foreign entity to a small level such as five percent. Many others may not have such specific restrictions in place but are in the hands of owners reluctant to cede control to an outsider.

The Tokyo Stock Exchange is unlisted and owned by 114 shareholders – mainly banks and brokerages – who would be unlikely to approve any buyout bid. Shanghai’s stock exchange ownership is based on a membership structure, and would likely require a change into a company-based equity model before any takeover could be contemplated.

“Beyond the fact that Asian exchanges are considered ‘national pride’, many are very behind the US and the European exchanges in terms of governance and ownership structures to facilitate any significant cross-shareholding structures or full scale mergers,” said Lee Seo Young, a partner at Oliver Wyman’s Asia Pacific financial services practice.

While the overseas M&A deals may not lead to full-blown acquisitions in Asia, they will put pressure on exchanges and authorities to facilitate more cross-border trading and alliances with other bourses.

Fragmentation
Moves are now underway to change some of the ownership structures – Thailand’s stock exchange is set to demutalise and list on the exchange by 2012 But there is another huge issue blighting the region’s markets which would put off potential bidders.

Asia’s lack of a regional regulator means it hasn’t undergone any of the cross-border market liberalisation measures seen in the west such as Europe’s Market in Financial Instruments Directive (MiFID). This means there is a huge fragmentation of rules and regulations between markets, limiting the scope for cross-border trading and reducing liquidity.

The most hopeful looking move to counter this problem is the planned trading link in South East Asia’s markets, with Singapore, Malaysia, Philippines and Thailand planning to have their bourses linked-up by the end of this year.

But against the backdrop of the major transatlantic tie-ups, this plan is looking fairly small beer.

“The problem with this is it’s not quite the right jurisdictions – to get something big going you need the likes of Tokyo, Shanghai, Hong Kong and India to be involved and that’s not looking likely just now,” said Alan Ewins, who heads up law firm Allen & Overy’s Asia-Pacific financial regulation practice.

Despite their geographical proximity, political, economic and organisational challenges make any potential marriage between the HKEx and the Shanghai or Shenzhen stock exchanges difficult.

Hong Kong, Shanghai and Shenzhen together raised $110bn in IPO proceeds in the first eleven months of 2010, 1.4 times the amount raised in New York, Nasdaq and London combined.

“Just from witnessing the wave of consolidation in other markets, we would expect the Asian governments to support formation of partnerships around products and liquidity access,” said Oliver Wyman’s Young.

This might also bring some hope to the alternative trading platforms, who will have viewed the deals in developed markets as an attempt to squeeze their market share.

“While the mergers in the US and Europe are aimed at lowering costs to counter alternative venues, in Asia, consolidation will benefit us,” said Ian Lombard, the chief operating officer of Tora, a dark pool operator backed by Goldman Sachs.

He argues that the M&A in America and Europe will prompt Asian exchanges to streamline trading rules a little quicker to allow more electronic trading.

Dark pool operators and other alternative venues have taken a large share of trading in Western exchanges but in Asia, these operators only have a significant presence in Japan. They are, however, keen to grow their business in Australia, Hong Kong and Singapore.

Tentative reforms and some eye-catching projects could herald a private sector-driven shake-up of India’s creaking railways, but deeper change is needed to tackle the supply bottlenecks that still crimp growth.

Once seen as a shining legacy of the British Raj and still one of the world’s biggest employers, India’s rail network crams 18 million people a day on to its ageing trains running from the foothills of the Himalayas to the southern beaches of Kerala.

Decades of low investment and policy stagnation mean India has fallen far behind emerging market peer China in building a network fit for Asia’s third-largest economy.

Contrasts abound. While Indian trains are notorious for 24-hour delays, China has made a global splash with a train whose top speed of 486 km/h will halve the travel time for the 1,318 km (819 mile) journey from Beijing to Shanghai to less than five hours by June.

“The Indian Railways is at an infancy as far as the reform and privatisation process goes,” said Ranveer Sharma, principal at Eredene Capital , a London-listed private equity investor in Indian ports and logistics.

There are some signs of change. The Indian government has initiated multi-billion dollar projects including a $90bn freight corridor to connect Delhi and Mumbai, with world-class industrial and commercial hubs to be built alongside.

Backed by funds from the Japan Bank for International Cooperation and the Sumitomo Mitsui Banking Corporation, officials say the track will cross six states and benefit 180 million people, three times the population of Britain.

A second giant freight line to the east will likely be backed by the World Bank. The private sector is moreover flexing its muscle with inner city metro rail projects that have been snapped up by big-hitting domestic firms such as Reliance Infrastructure Ltd and Larsen & Toubro.

“There are encouraging signs,” said S. Nandakumar, a Chennai-based infrastructure specialist at Fitch Ratings.

“If you look at it on a timescale of where we were say six or seven years ago, there’s definitely a lot more activity in the rail sector in terms of expanding infrastructure, in terms of involving the private sector.

“On the flipside, in comparison with what we’ve achieved on initiatives in some of the other sectors, it’s a little short.”

A world away from the country’s gleaming new airports, trains teem with rural migrants and hawkers left behind by India’s near double-digit growth story. More than 80 percent of the network was built before independence from Britain in 1947.

New Delhi has given a big push to infrastructure spending with a planned splurge of $1.5trn over 10 years. Railways could end up a laggard as the network receives five percent of funds from private money, the lowest figure of any major infra sector, though it takes $20bn in traffic receipts a year.

New destination?
The railway ministry has talked up the need for tapping the private sector for funds and in mid-2010 launched two policies to open up freight traffic to private firms.

The Private Freight Terminals (PFT) scheme lets private operators build and operate terminals on private land for a duration of 30 years and charge third parties for handling freight, boosting, for example, the business potential of ports and logistics firms.

Another initiative by the ministry was to let private firms run freight trains for certain commodities.

“Privatisation of the container trains and the recent PFT policy are perhaps the first seeds sown by the government towards substantial privatisation over the medium- to long-term,” said Eredene Capital’s Sharma.

“Foreign private equity investors, including Eredene, remain keenly interested in such developments.”

India’s infrastructure is a study in contradictions, with showcase projects such as Delhi’s revamped airport and a swish sea-link in the financial capital Mumbai set against road and power projects held up for years by red tape and funding gaps.

Projects such as the Delhi-Mumbai freight line are a statement of intent that India’s railway sector is playing catch-up with the likes of China, although the projects have proceeded slowly.

India needs such projects urgently to ease its expensive, inefficient and polluting reliance on road transport to move around freight, which has in turn fuelled soaring food prices.

British private-equity firm 3i Group Plc, which has a major presence in India, may expand its investment to include railways in a $1.5bn infra fund to be rolled out in 2011.

“There is investment required in railways, so for example some of the new ports that are being developed need additional rail links,” said Michael Queen, the chief executive of 3i.

“And of course, from an environmental perspective, moving cargoes like coal or iron ore is much more environmentally friendly doing it on railways rather than trucking it or building power plants in environmentally sensitive areas.”

A lot more could be done. India’s powerful Planning Commission, whose de facto head carries ministerial rank and is close to the prime minister, panned the railway ministry’s “lack of clear long term vision” in a 2010 report and urged private sector-driven reforms.

The panel recommended greater private participation in building world-class train stations and logistics parks, faster building of dedicated freight lines as in Delhi-Mumbai and “rebalancing” heavily subsidised passenger tariffs.

“Government monopoly”
Successive governments have ring-fenced the railways ministry as a gift to an ally. Prime Minister Manmohan Singh has handed the reins to Mamata Banerjee, the head of the Trinamool Congress party whose first priority is to win control of her home state of West Bengal in state elections due by May.

Her predecessor, Lalu Prasad Yadav, is a former chief minister of the state of Bihar and a one-time ally of Singh.

The temptation for a railway minister has always been to set up railway factories in their own states and keep passenger fares artificially low as a crowd pleaser, pushing a higher volume of freight traffic on to roads.

India’s bureaucracy is notorious for red-tape and delay that dates back to an older India before economic liberalisation in 1991. While there are signs this is changing in some sectors, the railways can still appear a law unto themselves, with their own budget, schools, hospitals and residential colonies to house some of their 1.4 million employees.

“These guys are sitting there and running the whole show as a government monopoly, which is a very weak incentive for commercial and economic decisions,” said a government official involved in the sector who did not want to be identified.

“They don’t want to let go of any control. They don’t want to introduce any competition. They don’t want to introduce any efficient private sector entities. It’s an island which has protected itself against modern influences.”

In the years from 1990 to 2007, which approximate to the start of India’s economic surge, the country built 960km of tracks compared with China’s 20,000km.

Losses from poor infrastructure shave off roughly one to two percent from India’s GDP growth.

The government official said it would take much greater political will or a serious crisis in the ministry’s finances to push real reforms. So far, he says, that has not happened.

“Private investments have been on the horizon for quite some time,” he said. “The problem is that the sun never rises.”

Miner Xstrata reported a better-than-expected 86 percent jump in annual profit on stronger commodity prices and gave a positive outlook for 2011.

The Anglo-Swiss miner said it was still assessing the impact on this year’s results from the recent flooding and cyclones in Queensland – where it has coal, copper and zinc operations – after it was forced to close some mines in the Australian state.

“As we stand at the moment we don’t see any significant impact on 2011 results,” Chief Executive Mick Davis told reporters.

Xstrata, the fifth-biggest diversified miner by market capitalisation, said the full impact would partly depend on the speed of recovery in infrastructure and on future rainfall, but noted that current spot prices had risen in response to the supply constraints.

Attributable profit, excluding exceptional items, for 2010 surged to $5.15bn from $2.77bn last year, beating the $5.05bn consensus of 18 analysts provided by the company.

The company reduced its gearing to 15 percent from 26 percent and its net debt by 38 percent to $7.6bn.

“Overall a solid set of numbers with growth supported by a strong balance sheet,” said Credit Suisse in a note.

The miner, one of the most heavily traded companies in London, said it planned to pay a final dividend of 20 cents a share, reflecting a return to pre-crisis levels and plans to continue a progressive dividend policy.

Xstrata, the world’s biggest producer of thermal coal, reported lower 2010 production for coal and a mixed performance for copper in the first week of this month, although prices rose for most of its commodities. Copper and coal are the group’s biggest earnings contributors.

A second wave of commodity price increases and a deteriorating British grocery market will hit profits at cleaning products maker McBride, it said on February 7, sending its shares to a 24-week low.

McBride, Europe’s biggest maker of own-brand household cleaning products for retailers, said a surge in the price of plastics and vegetable oils in recent weeks could add around £7m to its costs in the second half of its fiscal year, after an “£8m hit in the first half.

“In recent weeks, we’ve seen a second wave coming … an additional raw material spike which we will have to deal with,” chief executive Chris Bull told reporters.

A surge in the price of ICE Brent crude to around $100 a barrel, coupled with fresh increases in food prices, have sent shock waves through consumer products makers in recent weeks.

Unilever said in early February it would raise prices and slash costs to offset soaring costs.

“The market is clearly nervous on the issue of cost inflation across the consumer sector and there is still considerable uncertainty around when costs may start to abate,” said Investec analyst Nicola Mallard, cutting her full-year pretax profit forecast for McBride a fifth to £28m.

Analysts think makers of branded consumer products are in a stronger position to drive through price increases with retailers than manufacturers of own-brand goods like McBride.

McBride, which supplies firms like Tesco and Carrefour with own-label goods ranging from dishwasher tablets to deodorant, said it aimed to achieve a further £11m in annual cost savings over the next two years to help absorb the pain.

Bull said these savings could include closing factories and moving manufacturing to cheaper locations.

He was also confident about longer-term prospects for the firm, noting good growth in central and eastern Europe and the possibility that more consumers will switch to cheaper own-brand products as austerity measures bite.

Tough times in UK grocery
McBride said operating profit before goodwill and one-off items fell 24 percent to £20.2m in the six months ended December 31, due to a lag in recovering previous increases in input costs.

Sales rose 2 percent at constant currencies to £407.9m, while the interim dividend was kept at two pence a share.

Bull said Britain’s grocery market in particular hit “a very difficult period” in December and January and described the outlook for consumers as challenging amid rising bills, taxes and public spending cuts.

The level of promotions by branded manufacturers remained at a high level, though below a year ago, he added.

Bull said McBride would continue to look to expand in central and eastern Europe, and that southeast Asia and Australia were also attractive markets in the near term.

The group also plans to focus on growth areas in its household goods markets, like laundry liquids and non-aerosol air fresheners, and expand in fast-growing personal care markets like skincare products for men and oral care.

President Barack Obama stepped up efforts to woo the US business community on February 7, seeking its help to tackle “burdensome” corporate taxes in a speech to a business group that has long been a fierce critic.

Obama, on a drive to win over business and independent voters before the 2012 presidential election, also repeated a promise to advance trade deals with Panama and Colombia that would help US companies, but he did not lay out a timetable for getting the pacts passed.

“I understand the challenges you face. I understand you are under incredible pressure to cut costs and keep your margins up. I understand the significance of your obligations to your shareholders and the pressures that are created by quarterly reports. I get it,” Obama told the powerful US Chamber of Commerce, which has often opposed the president for what it sees as his “big government” agenda.

Members of the Chamber, which the White House has accused of funding ad campaigns against Democrats during last year’s congressional elections, listened politely but were mostly noncommittal in response to the president.

White House spokesman Robert Gibbs later told reporters that Obama had not gone seeking applause.

“Another barrier government can remove is a burdensome corporate tax code with one of the highest rates in the world,” Obama said.

Calling taxes a burden chimes with the view of the corporate world, and is another example of Obama’s efforts to repair relations between the White House and businesses after steep losses by his Democrats in November elections.

Chastened by that defeat, Obama has tried to do a better job of communicating with business, dialing down a sometimes acrimonious debate during his first two years in office.

‘Change in tone’
“We thought it was a good change in tone,” the Chamber’s president, Thomas Donohue, told Fox News Channel. “He came, he visited, and we look forward to doing things together.”

Others in the audience at the Chamber’s headquarters – a stone’s throw from the White House – welcomed Obama’s speech but were still wary of him.

“Are they going to follow through or is this just the politics of saying the right thing and it stops there?” said Juliana Zoto Efessiou, who launched a social media venture after her bridal boutique failed during the recession.

With one eye on re-election, Obama needs to bring down the unemployment rate of nine percent and wants companies to hire more. He repeated a call for business to step up investment and hiring to mobilise “nearly $2trn sitting on their balance sheets.”

“Many of your own economists and salespeople are now forecasting a healthy increase in demand. So I want to encourage you to get in the game,” Obama said.

Business had fought Obama’s massive overhaul of Wall Street regulation and reform of the healthcare system, and it resented the president’s sharp rhetoric on executive pay during the height of the financial crisis.

The White House, while irritated by the Chamber’s opposition to policies it says will help the economy, has sought to mend relations by employing softer presidential rhetoric and staffing choices that appeal to the business community.

Obama picked Bill Daley, formerly of JPMorgan Chase, to be his chief of staff and recently brought on General Electric Co Chief Executive Jeffrey Immelt as his new top outside economic adviser. He also agreed on a tax deal with Republicans last year and has promoted initiatives to boost US exports.

While talk of cutting overall corporate tax rates goes down well with some American companies, Obama might upset others by closing loopholes and slashing deductions.

Business had hoped Obama would outline a way forward for stalled trade agreements with Panama and Colombia. But the president made only brief reference to those pacts.

“We finalised a trade agreement with South Korea that will support at least 70,000 American jobs. And by the way, it’s a deal that has unprecedented support from business and labour, Democrats and Republicans,” he said.

“That’s the kind of deal that I will be looking for as we pursue trade agreements with Panama and Colombia, as we work to bring Russia into the international trading system.”

UBS said it expects to win back more money from clients in 2011 and has laid the foundations for a rebound in its investment bank as chief Oswald Gruebel turns around a bank almost felled by the crisis.

UBS said it had seen improvement across all its businesses in the fourth quarter – with total net new money of 7.1 billion Swiss francs – although inflows were “very small” at its core wealth management unit after 1 billion in the third quarter.

“We are optimistic that overall positive net new money inflows will continue in the first quarter. For the full year, we believe that net new money will strengthen noticeably,” UBS said in a statement.

Clients rattled by massive writedowns on toxic assets and a tax dispute with the United States had pulled nearly 400 billion francs from Switzerland’s biggest bank in recent years.

“The results are a relief after the poor results of US brokers and those from Deutsche Bank and even Julius Baer,” said Helvea analyst Peter Thorne. “It is a relief to hear their optimism for 2011.”

Gruebel’s overhaul of the investment bank started to pay off in the fourth quarter as equities and fixed income, commodities and currencies revenues improved, though bigger losses on the bank’s own credit, as well as losses on student loans, kept net profit to just 75 million Swiss francs ($78.35m) after a surprise loss for the previous three months.

UBS described the investment bank results as “unsatisfactory in relation to our ambitions” but expects some improvement in the business’s trading results in the first quarter, though this depended largely on market conditions.

UBS was forced to cut risky but potentially very profitable proprietary trading in favour of client flow business after it took huge losses in the financial crisis pushing it to take a bailout from the Swiss government in 2008.

“While we made substantial progress in 2010, we are fully aware that we have to continue to improve our results,” Gruebel said in a statement.

Bank secrecy pressure hurts
While the bank won client cash in the Asia Pacific region – traditionally an area of strength for UBS – and among the ultra wealthy and Swiss customers, it continued to bleed a small amount of assets both onshore and offshore in Europe, where neighbouring countries have attacked Swiss bank secrecy.

Wealth management revenues rose two percent in the fourth quarter, though the unprecedented strength of the Swiss franc partly offset increased client activity, UBS said.

UBS said it made total litigation provisions of 230 million francs in the quarter, mainly in its wealth management Americas business, which pushed up operating expenses.

While this led to a pretax loss for the Americas business, which was hit hard by a tax dispute that ended with UBS being forced to hand client data to US authorities, it attracted 3.4 billion francs of new money after a small net outflow the previous quarter.

UBS, which is still held in suspicion by the Swiss public after booking the biggest loss in the country’s history in 2008, said it would pay out 10 percent less in bonuses for 2010, cutting the bonus pool to 4.3 billion francs.

It also said 1.550 billion francs of the bonus pool would be be deferred to future years.

Plane maker Boeing received unfair subsidies from the US government, a World Trade Organisation report said recently, according to Boeing’s European rival Airbus.

The two companies disagreed over the extent of the subsidies outlined in the report, which was delivered to the US government and the EU Commission but not released publicly.

Airbus said the report showed Boeing had received at least $5bn in illegal subsidies and was only able to launch its 787 Dreamliner with such support. Boeing denied the assertions.

The US and EU, both trading superpowers, have been fighting cases against each other in the WTO for more than six years over each other’s subsidies for large passenger aircraft.

Boeing’s stock, a Dow component, showed little reaction to the WTO report. Shares were up just eight cents at $69.31.

“I don’t think there’s clarity as to what this really means. It seems to be a lot of noise,” said Alex Hamilton, managing director of EarlyBirdCapital, a boutique investment bank.the dispute as Airbus and Boeing battle for the $1.7trn market.

The report is still confidential, but even Boeing acknowledges that the WTO has backed some of the EU claims. However, the two sides disagreed strongly over the amount of condemned Boeing subsidies and how they compared with those given to Airbus.

The findings came as a US Air Force decision was expected within weeks on whether to award Boeing or Airbus parent EADS a contract worth $25bn to $50bn for refueling tankers. But EarlyBird’s Hamilton said the WTO report was likely to have little impact on the US government decision.

Both plane makers have supporters in the US Congress, as Boeing would build and finish the tanker in Washington state and Kansas while Airbus would assemble it in Alabama.

Senator Richard Shelby of Alabama said that the WTO report “unquestionably states that Boeing received significant government subsidies prohibited by the WTO.”

“Today’s decision should end Boeing supporters’ attempt to derail the tanker competition by arguing that the trade dispute is one-sided,” Shelby said in a statement.

On the other side, Senator Pat Roberts of Kansas said: “Attempts to skew this ruling in the EU’s favour are an exercise in distraction. Once this ruling is made public in the near future, the sunshine will refute much of the claims by the EU and truly indicate where the market-distorting benefits flowed.”

With no end to the litigation in sight, both sides have periodically called for a negotiated end to the dispute, as EU Trade Commissioner Karel De Gucht did in September when an interim version of the report was issued.

His spokesman said the report confirmed those initial findings, in comments suggesting Brussels was not keen to raise the stakes, or wanted to play down a previous WTO ruling that condemned its own support for Airbus.

“This solid report sheds further light on the negative consequences for the EU industry of these US subsidies and provides a timely element of balance in this long-running dispute,” spokesman John Clancy said in a statement.

One EU diplomat said a political solution was preferable.

“Given the state of the global airline industry today, a political agreement is important for both sides of the Atlantic,” the diplomat said.

The ruling, like the interim report, was handed only to the parties. It will not be published for several weeks while being translated into French and Spanish.

US Trade Representative Ron Kirk’s office said it could not provide detailed comment now as the report was confidential.

“Despite that the EU has publicly commented on the report, at this time we will simply say that the United States is confident that the WTO will confirm the US view that European subsidies to Airbus dwarf any subsidies that the US provided to Boeing,” spokeswoman Nefeterius McPherson said.

Massive subsidies
Airbus said the report would show Boeing had received billions of dollars in illegal subsidies, depriving Airbus of $45bn in sales, an indication of what the EU could seek in sanctions if the case moved to retaliation.

But Boeing disputed Airbus’s figures and said the ruling would not require any change in policy or practice as far as Boeing was concerned.

WTO experts found last year that Airbus received illegal export subsidies from European governments and both sides have appealed against that ruling.

Appeals involving prohibited export subsidies are supposed to be dealt with in 60 days under WTO rules, but this case is so complicated that the WTO’s appellate body has said it will not come to a conclusion until some time this year.

Boeing says the research and development grants it received pale into insignificance beside the support for Airbus.

In the Airbus case, WTO judges found the company had been able to launch a series of passenger aircraft only thanks to the government support and called for an end to export subsidies.

Both sides have an interest in clarifying the rules for how governments can facilitate the development of new aircraft in a fair manner.

It could take until much later this year for the appeals process in both cases to run its course, but the two governments, aware that Brazil, Canada, China, India, Japan and Russia have en eye on the market, are eventually likely to negotiate a settlement.

As Berlin presses its eurozone partners to introduce tough German-style deficit rules, first cracks are emerging in the country’s own commitment to the “debt brake” law it holds up as a model for others.

Chancellor Angela Merkel is pushing other European countries to enshrine binding rules based on the German legislation in their constitutions as part of a new anti-crisis package meant to overcome the currency bloc’s debt crisis.

The German law forces the federal and state governments to virtually eliminate their structural budget deficits over the next five to 10 years. Already eurozone members such as France and Spain have expressed interest in pursuing similar steps.

The appeal is simple: national deficit limits that reinforced the EU’s discredited Stability and Growth Pact would show markets that leaders are serious about getting their finances in order and reduce the risk of future crises.

But economists who have studied the effectiveness of fiscal rules in shaping policy are sceptical about whether Germany’s debt-brake law can be successfully exported to other members of the currency bloc with no tradition of fiscal discipline.

Some worry that such a drive could even increase the risk of member states pursuing the kind of creative accounting that helped get the bloc into its current mess.

“I am far from sure that these rules would work,” said Alberto Alesina, an economist at Harvard University. “A government can put rules in place but experience shows that if they want to find a way around them and pursue a different policy, they will.”

Debt denial drama
Exhibit A is Germany itself.

Late last year, the Bundesbank and the government’s “wise men” panel of economic advisers, criticised Merkel’s coalition for violating the spirit of its own debt-brake law after Berlin refused to adjust its consolidation plans to take into account better-than-expected 2010 tax revenues.

Had it done so, its scope for new borrowing in the coming years would have been sharply reduced because 2010 is used as the base year for its goal of cutting the structural deficit to 0.35 percent of GDP by 2016.

Signs of backsliding are also evident in Germany’s most populous state, North Rhine-Westphalia, where a regional court is threatening to block plans by the minority government of Social Democrats (SPD) and Greens to sharply increase borrowing – in part to cover losses at regional Landesbank WestLB.

Under the state government’s plan, net new borrowing would surge to €7.8bn this year, compared to €4.1bn in 2009. That would cast doubt on NRW’s ability to meet its commmitments under the debt-brake law, which gives Germany’s regions until 2020 to slash their deficits to near zero.

“If the state government sticks to its stance I don’t think NRW will be able to achieve the limits set out in the law,” said Juergen von Hagen, an economics professor at Bonn University. “Then other German states will say, if the big guys don’t have to play by the rules why should we?”

Von Hagen believes a similar debt denial drama could play out in Europe if other countries follow Germany’s lead and introduce tough new fiscal rules in their national legislation.

He points to the example of the US, where many states have rules in place to limit public debt but have found ways around them by inventing new financial instruments that are not defined as debt.

“One of the dangers of rules like this is they create a lot of opacity in public finances. You run the risk of creating Enrons all over the place,” he said, referring to the Texas-based energy services group that collapsed in 2001 when its off-balance sheet accounting tricks came to light.

French resistance
Not all economists share this scepticism about extending Germany’s debt-brake law across Europe.

Charles Wyplosz, an expert on international economics at the Graduate Institute of International Studies in Geneva, has argued for years that EU-wide budget rules cannot work because they conflict with the sovereignty of the bloc’s member states.

He sees Germany’s 2009 law as a potential “game changer” precisely because it was self-inflicted rather than imposed by Brussels. But even Wyplosz admits that the political hurdles to extending it are formidable.

As a member of a special commission set up last year by President Sarkozy to study the introduction of a debt rule in France, he says it quickly became clear that opposition from lawmakers on the right and left would doom the plans.

In the end, the commission led by former IMF head Michel Camdessus came out with vague recommendations that Wyplosz refused to endorse.

“When the lawmakers in Sarkozy’s own party argued against it, then it was clear there was no majority and it wouldn’t go through,” he said.

That suggests France’s pledge to follow Germany’s lead and write new budget-balancing rules into its constitution should be taken with a grain of salt.

Hungary is another EU country whose commitment to fiscal discipline has fallen victim to shifts in the political tide.

In 2008, Budapest was hailed as a fiscal policy model for setting up an independent council to oversee budget planning and act as a counterweight to spend-thrift governments. Now that council has been stripped of its funding and staff by the new government of Prime Minister Viktor Orban.

Zsolt Darvas, a fellow at the Brussels-based Bruegel think tank, says the case of Hungary shows the risk of imposing fiscal rules in countries where there is no broad public consensus for economic rigour – the rules can vanish as quickly as they come.

He says the real lesson from the eurozone crisis is that markets have taken over as the guardians of fiscal rectitude in Europe by pushing up the borrowing costs of countries who fail to put their finances in order.

“Rules can be good, but markets have become a much more important disciplining factor,” he said.

Wages, pensions, unemployment insurance, welfare benefits and collective bargaining are under attack in many areas as governments struggle to reduce debts swollen partly by the cost of rescuing banks during the global financial crisis.

The EU, which long trumpeted a European social model with a generous welfare state, social partnership between unions and employers and a work-life balance featuring limited working hours and long paid holidays, has lost its swagger.

“The prevailing philosophy is that people have been paying themselves too much in some countries and we should be more like Germany, where people didn’t get a real pay raise for 10 years,” says John Monks, head of the European Trade Union Confederation.

Unlike bankers and bondholders, the European social model is being given a haircut – a light trim in Nordic countries but a brutal short-back-and-sides in some others.

The roll-back of wages and social benefits is toughest in Greece, Ireland, Romania and Latvia, which are under international bailout programmes designed by the International Monetary Fund and the European Commission.

“The messages are the same: cut wages, public sector wages, minimum wages, reduce benefits and raise retirement ages and also reduce employment protection in certain countries,” Monks told reporters in an interview.

Widening inequality
Under the banner of fiscal sustainability, Europe’s mostly centre-right governments are unwinding some cherished gains of the era of social progress that began after World War Two, at the price of widening inequality.

A “competitiveness pact” which German Chancellor Angela Merkel wants the EU to adopt in March includes a greater harmonisation of retirement ages and the abolition of inflation-indexing of wages, according to a leaked draft.

“You cannot share a single currency with completely divergent social systems,” Merkel told the World Economic Forum in Davos.

She and French President Nicolas Sarkozy ran into resistance when they put the proposals to fellow EU leaders, some of whom saw them as socially explosive.

Greek Prime Minister George Papandreou, one of Europe’s few remaining socialist government chiefs, lamented in Davos that the global crisis had speeded a race to the bottom in labour standards and social protection in the developed world.

Emerging countries such as China and India had achieved competitiveness through low wages, no collective bargaining, little or no healthcare and social insurance and disregard for the environment in exploiting resources and production.

“The question for Europe is: do we emulate that model? … because what we are seeing is on the one hand a race to the bottom at the level of the middle class and working class, and at the other end a race to the top,” Papandreou said.

Greece, rescued from the brink of bankruptcy last May, has adopted deep austerity measures in return for EU/IMF loans, including steep public sector pay and pensions cuts.

The conditions include a rewriting of its labour laws that trade unions and the labour minister say would gut workers’ rights to collective bargaining and job security.

Ireland cut its minimum wage by 11 percent to €7.65 ($10.40) an hour under a 2011 budget that forms the basis of its EU/IMF assistance programme.

Where such measures have not been directly imposed by the IMF and the European Commission, they are being adopted out of fear of having to request a bailout (Spain and Portugal), or of the loss of a top-notch credit rating (Britain and France).

Sarkozy forced through an increase in France’s minimum retirement age to 62 from 60 last year over the resistance of trade unions which staged seven one-day strikes.

Spain and Portugal, under much fiercer bond market pressure, have avoided such labour unrest by negotiating social pacts.

The Spanish government, unions and employers signed an agreement at the start of February that will gradually raise the retirement age to 67 from 65, with pensions based on the last 25 years’ earnings rather than the last 15 years.

The accord included a reform of collective bargaining and measures to fight 20 percent unemployment, particularly targeted at young job-seekers and the elderly unemployed.

No alternative?
In words that recall former British Prime Minister Margaret Thatcher, Merkel says there is no alternative to trimming Europe’s entitlement programmes, although Germans will be spared the harsher measures being enforced elsewhere.

But Monks insists that Berlin’s own example proves there is an alternative.

Germany’s booming growth, and the parallel recovery in the Netherlands and Austria, whose economies are intertwined with Germany’s, is based on long-term investments in high-quality manufacturing industry, he said.

“These are not low-wage countries. They have privileged public servants, strong employment protection laws, strong collective agreements.

“These are not short-term, shareholder, value-driven, flexibilised economies. Their prosperity is driven by long-term investment in technology and innovation,” Monks said.

Moreover, Germany subsidised companies to keep staff on the payroll working short-time when order books were empty, enabling them to retain a skilled workforce for the recovery.