Bank under fire over interest rates: Securities houses thought to have lost millions on futures contracts after Friday's money market confusion

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The Independent Online
CITY anger grew at the weekend over the Bank of England's conduct in the money markets on Friday, as it became clear that several securities houses had lost millions of pounds in the short-sterling futures market.

Some firms, thought to include Goldman Sachs, had used the market to buy the September futures contract earlier in the week in a bet that interest rates would not rise until later in the autumn.

When speculation that the Bank was on the point of raising base rates swept the market on Friday, after it unexpectedly accepted higher money market rates, the price of the September contract dropped 33 basis points.

Steven Bell, chief economist at Morgan Grenfell, said: 'If there is going to be no base rate rise the Bank should have told us they had a new operating method. If we are going to have a rise it was a stupid way to introduce it.'

Analysts said Bank officials were informally suggesting no change in rates was imminent. If true, a sharp fall in sterling and gilts prices would be inevitable.

The pound rose 2.5 pfennings to DM2.4423 and half a cent to dollars 1.5368 on Friday on the assumption of a rise of at least half a percentage point in rates, while the price of longer-dated gilts advanced on the expectation that there would be an early base rate rise helping to cap inflation.

Mr Bell said: 'The signal of an impending base rise was taken well by the gilts and currency markets on Friday. To take it away again would be ridiculous.'

Robert Thomas, a currency analyst at NatWest Markets, said: 'Having expectations raised and not fulfilled is the worst possible outcome. If interest rates do not go up sterling will certainly have a big adverse reaction.'

Bank officials suggested to City economists that the increase of more than 75 basis points accepted by the Bank in Friday's sale of Treasury bills - a regular part of the programme of funding government debt - was a routine reaction to earlier increases in money market interest rates. The Bank's daily money market operations are the usual channel through which it signals desired base rate changes.

Few in the City believed this explanation. Most agreed the Bank could easily withdraw a Treasury bill auction if the market was pushing for an increase in rates that it did not want to validate, although it has not had to do so with rates falling for nearly two years.

Adam Cole, an economist at James Capel, said the Bank's failure to pull the Treasury Bill auction indicated that it was not unhappy with developments.

According to the recently published minutes of the May meeting between Eddie George, the Governor of the Bank, and the Chancellor, Mr George made it clear that there were strong advantages in increasing interest rates before inflation got worse rather than reacting after the event. Several of the indicators watched by the Bank have been showing early signs of faster price increases.

One indicator is survey evidence on inflation expectations. The Confederation of British Industry's July survey showed that a rise in output price expectations reported in June had been sustained this month, while the July Purchasing Managers' survey showed purchase prices at their highest level since the survey began in 1991.

Latest figures on a second indicator, narrow money growth, are due today. Its growth is expected to have slowed in July, but the annual rate of increase remains above the top of its monitoring range.

The Bank of England's inflation report, published late tomorrow, will reveal its full assessment. Markets are primed for a pre-emptive interest rate rise, reasoning that the Chancellor and Governor would prefer to tighten policy rather than see sterling and gilts sold off as a result of confusion.

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