Budget cut in interest rates ruled out: City says 5.5% sweetener is designed to offset expected tax increases and cuts in public spending

TAX increases and public spending cuts in next Tuesday's Budget looked a racing certainty in Westminster and the City yesterday after the Bank of England unexpectedly cut interest rates from 6 to 5.5 per cent, the lowest for 16 years.

Most banks and building societies held fire on mortgage rates, waiting to see whether the Budget would herald another fall in base rates or include measures affecting savings or the housing market. But the Chancellor said the cut took 'full account' of his Budget, in effect ruling out another on Tuesday.

The Nationwide building society and National Westminster Bank announced immediate cuts, bringing the basic rate down from 7.99 to 7.74 per cent. A borrower with a pounds 30,000 endowment mortgage will save pounds 4.69 a month.

The City interpreted the cut as a pre-emptive sweetener for tax increases, public spending cuts and a possible reduction in tax relief on mortgage interest payments in the Budget. The Treasury may feel a cut is needed to prevent the Budget measures from damaging recovery.

Some City economists and Tory backbenchers argued that by ruling out a full point cut in base rates on Budget day the Chancellor was signalling that tax increases or spending cuts were unlikely to be large. Whitehall sources said interest rate cuts since October 1990 had been worth an extra pounds 12bn to companies and had brought mortgage payments down by pounds 170 a month.

Although the outline of certain spending cuts has been decided, on the politically sensitive question of a compensation package for value- added tax on fuel government sources would say only that 'good progress' had been made and that it would be completed by Tuesday.

'The tightening could be small. That would be a big mistake', said Roger Bootle, economist at Midland Bank. He said the Chancellor might raise as little as pounds 1bn-pounds 2bn in the Budget, but argued it would be better to raise pounds 6bn-pounds 7bn and to cut interest rates to 4 per cent.

Base rates are now at their lowest since 1977, having spent 10 months at 6 per cent. The financial markets expect a cut to 5 per cent by the spring, with some economists expecting it before next year.

John Major told the House of Commons that interest rates were last as low when Labour was in power. 'But at that time inflation was 13 per cent and pensioners and savers were robbed of 7 per cent,' the Prime Minister said. Real interest rates - the actual rate minus the rate at which inflation erodes the lender's capital - is now lower than through almost all the 1980s, but higher than in most other industrial countries.

Gordon Brown, shadow Chancellor, said: 'The Chancellor should have cut interest rates earlier. He must now also introduce an industrial skills policy that is necessary for sustainable growth.'

The Chancellor decided to cut rates last week, but the precise timing was left to the Bank of England - a practice to be followed with future changes. Eddie George, Governor of the Bank of England, said its extra freedom could help to remove the impression that the timing of base rate changes was dictated by political motives.

The Bank said this was 'a small step' towards further independence over interest rates. But the Treasury made it clear the Chancellor would still decide whether to change rates and by how much.

The Treasury said yesterday's rate cut was 'sensible and fully consistent with the Government's inflation target'. The growth of the money in the economy remains under control, house prices have risen only slightly, the pound is 3 per cent stronger than in January, inflation is weak and rates have fallen elsewhere in Europe.

Financial markets took the cut well. Share prices had a roller-coaster ride, with the FT-SE 100 index closing 1.3 points down at 3,069.3. The pound rose 0.4 points, closing at 81.4 per cent of its 1985 value.

Matthew Symonds, page 18

View from City Road, page 32

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