Bank dampens rate hopes despite recession warning

THE PROSPECT of another cut in UK interest rates before Christmas faded yesterday after the Bank of England's quarterly economic assessment proved less gloomy than feared. In its regular inflation report, the Bank cut its forecasts for both economic growth and inflation, and said there was now a one-in-four chance of recession next year.

Mervyn King, deputy governor of the Bank, warned that unemployment was likely to rise over the next 12 months.

City analysts said yesterday's jobless figures - which revealed increases in both key measures of numbers out of work for the first time in almost six years - could mark the beginning of a sustained period of rising unemployment.

Despite the warnings on unemployment and growth, the overall tone of the Bank's inflation report was less gloomy than the City had expected, prompting a rise in the value of leading company shares. The FTSE 100 closed up 44.5 points at 5,476.8. Traders said a string of better-than- expected company results helped sentiment.

The pound spiked upwards against the Deutschmark following the release of the report, but fell back to close down over a pfennig at DM2.787.

Analysts were braced for a downbeat report from the Bank and deep cuts to growth forecasts following last week's larger-than-expected 0.5-point cut in UK interest rates. To the City's surprise, however, the Bank produced similar forecasts to those released by the Treasury in the pre-Budget report.

Several analysts said that both the Bank and Treasury were painting too rosy a picture of economic prospects. Mark Wall of Deutsche Bank said: "We believe the Bank is too optimistic on the outlook for the economy and in order to avert a full-blown recession, we expect the Bank to reduce interest rates to 5 per cent by the end of the year."

The Bank's central projection is that growth in gross domestic product (GDP) will slow to around 1 per cent next year, before rebounding in 2000.

At the press conference following the release of the report, Mr King stressed that although the Bank's Monetary Policy Committee did not think recession was the most likely outcome, risks to activity "remained on the downside".

The Bank also cut its forecasts for inflation. In August RPIX - the underlying rate of inflation targeted by the Bank - was forecast to peak at around 3 per cent early next year before falling towards target by summer 2000.

Now the Bank believes inflation will peak at around 2.8 per cent next year - primarily because of one-off effects associated with the introduction of the minimum wage - and will quickly return to target.

By the middle of 2000, inflation could fall below target, the Bank said, prompting analysts to speculate that interest rates would come down again, although possibly not until next year. Michael Saunders at Salomon Smith Barney/Citibank said: "Given the MPC's forecasts, a December cut now seems unlikely unless new global shocks materialise. January or February seem more likely bets."

Mr King said uncertainty about the reliability of average earnings data meant there was "considerable uncertainty" about the Bank's inflation forecasts. Publication of the average earnings index - scheduled for yesterday along with the unemployment figures - has been suspended until an inquiry into the series has been completed.

The unemployment data showed that the claimant count rose by 6,800 in October, while the ILO jobless measure - a broader measure of unemployment - rose by 3,000 in the three months to September.

Hamish McRae, page 22