Booming economy scares City

Inflation edged lower last month thanks to the strong pound, which also hit export orders. But the booming economy has taken manufacturing output to its highest since May 1995, while consumer credit set a new record.

The City mood has shifted in favour of the need for an increase in interest rates following a batch of figures this week showing the economy building up a strong head of steam.

Most analysts expect the move on 7 May, right after the election.

Interest rate gloom accounted for a drop in share prices. The FTSE 100 index tumbled more than 74 points to 4,258.1.

"The strength of demand in the economy will not stop inflation falling this year, but it will affect the outlook for 1998," said Michael Saunders, UK economist at Salomon Brothers.

Minutes of the February meeting between Bank of England Governor Eddie George and the Chancellor of the Exchequer, published on Wednesday, showed the Bank urging an immediate base rate rise. This week's figures, including a big drop in unemployment and increase in earnings growth, will have reinforced its message.

The Government's target measure of inflation, retail prices excluding mortgage interest rates, fell to 2.9 per cent in February from 3.1 per cent. Economists still think there is a good chance it will hit its 2.5 per cent target temporarily this year as the effect of the strong pound feeds through to goods on the high street.

The headline rate edged down from 2.8 per cent to 2.7 per cent. Seasonal foods and household goods prices contributed most to the decline.

The figures, published on the anniversary of the BSE crisis, showed beef prices only 1.6 per cent lower than a year earlier. Clothing and footwear prices displayed their usual post-sale rebound.

The rate of increase in goods prices generally was the lowest since May 1995 due to the sterling effect. However, services inflation climbed to its highest for three years.

The outcome of the tug-of-war between the two categories will determine the path of inflation over the course of the next few months.

Other figures yesterday confirmed that demand is booming. The latest survey of manufacturing by the Confederation of British Industry showed that export orders have dropped to their lowest level since November 1993.

But domestic orders more than offset this, and the volume of output was at its highest for nearly two years. The balance of firms increasing rather than reducing output rose to 25 per cent from 16 per cent last month.

Sudhir Junankar of the CBI said: "It is a more encouraging picture on output."

Separate statistics published by the Bank of England showed that growth in M4, the broad money measure whose pick-up has alarmed Eddie George, climbed to 11.3 per cent in February.

The high street banks reported that consumer credit set another new record. New loans amounted to pounds 626m during the month, about half as much again as the recent monthly average.

The surge in personal loans took the edge off slight falls in mortgage lending by banks and building societies.