City lambasts Chancellor
Saturday 06 May 1995
The surprise decision yesterday by Kenneth Clarke, the Chancellor, not to increase base rates from their current 6.75 per cent drew near-universal criticism from the financial markets. City analysts said that the failure to move had undermined the hard-earned credibility of monetary policy.
The pound's trade-weighted index reached a new low of 83.5 before recovering a fraction to end the day 1 per cent lower at 83.6. Traders warned that there was a danger of a further onslaught on the currency next week, including Monday, when the UK markets are closed.
In a rare display of unanimity, senior City economists condemned Mr Clarke's decision, which most believed had overruled the views of Eddie George, Governor of the Bank of England. Keith Skeoch, chief economist at James Capel, said: ''Mr Clarke is playing with fire. He set up the markets for a tightening of policy and didn't deliver. It is seen as politics interfering with the management of the economy."
Geoff Dicks, chief UK economist at NatWest Markets, said: "It was a high- risk decision. This is the first time the authorities have fallen behind what the markets thought was needed."
Bill Martin, UBS's chief economist, thought the failure to raise base rates marked a turning point in monetary policy. "We are in for gradual relaxation of the inflation goals," he said.
The Chancellor was on the defensive about yesterday's announcement, saying: "The idea that I take decisions with reference to the short-term political considerations of the day is wrong." He argued that there was no sign of undue demand pressure in the economy, adding that the peak in interest rates was nearer than it had been.
Mr Clarke said retail sales and the housing market were weak, while there was no evidence of a pick-up in earnings growth. The surge in commodity prices was levelling off. In addition, the Confederation of British Industry's latest monthly survey had shown a marked fall in manufacturers' expectations of price increases.
"We have an overall picture which shows that we are sustaining growth and have a healthy and balanced recovery," he said.
Mr Clarke and Mr George also had a preliminary estimate of retail price inflation in April - due to be published on Thursday - available at their meeting. It is expected to be better than the March figure of 2.8 per cent (excluding mortgage interest payments) as the effect of introducing VAT on domestic energy bills last April drops out of the 12-month comparison.
The Chancellor's other argument against raising interest rates again this month was that national output had not risen as much as the official gross domestic product figures suggested in the first quarter of this year. The official rise was 0.8 per cent, the same as the final quarter of 1994.
Mr Clarke called this a "very surprising" figure. He suggested that the National Lottery and mild weather explained its strength. "We will see later that the GDP figure will be revised," he said, suggesting that financial markets had over-reacted.
However, City economists dismissed this argument. Steven Bell, at Morgan Grenfell, said: "If there are definite distortions, they should have been explained by the statisticians when the figures were announced." Like many, he thought the preliminary estimate was more likely to be revised up.
Although the pace of recovery has slowed, most observers think there were strong arguments - on top of sterling's 5 per cent decline this year - for increasing base rates half- a-percentage point. The Treasury spelt out many of them in its monthly monetary report.
Apart from the rise in GDP, taking it to a level 3.9 per cent higher than a year earlier, underlying inflation rose between February and March.
Surveys suggest that growth in manufacturing is still strong, with capacity utilisation its highest since October 1988.
Mr Clarke insisted yesterday that he remained committed to the 1-4 per cent inflation target, and he was "conscious" of the ambition to get it in the bottom half of the target range by the end of this parliament.
He said: "There are no new inflation pressures to justify my raising interest rates in the light of policy measures already taken." Previous base rate rises and tax increases were still working through.
A majority in the financial markets believe the base rate rise has simply been postponed to the next meeting on 7 June.
The Chancellor could draw some shreds of comfort from the reaction of the gilts market, however. Although the decision hit long-term gilts, a strong rally in the US Treasuries market helped limit the damage. And short sterling futures, used to bet on interest rate moves, made strong gains. The market points to expectations of base rates at 7.32 per cent in September, down from an expected 7.6 per cent.
Gilts analysts said the market would be nervous until the publication of the Bank of England's Inflation Report on Thursday. If that showed the Bank to be more concerned about inflation, it would be "pretty grim" for gilts, according to Nigel Richardson, analyst at Yamaichi.
The FT-SE 100 index closed 12.6 points down at 3,261.7. Trading was edgy due to worries about the impact of the weak pound.
Outside the Square Mile, the absence of an interest rate rise was welcomed by industry and mortgage lenders.
Comment, page 17
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