Economists warn of further market chaos if base rates rise

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The Independent Online
The Bank of England could trigger another bout of turmoil in the London stock market if it raises interest rates this week, leading monetarist economists have warned.

The shadow monetary policy committee, which includes Sir Alan Walters, Lady Thatcher's former economic adviser, and Professor Patrick Minford from Cardiff Business School, urged the Bank's Monetary Policy Committee to keep base rates unchanged at 7 per cent when it meets on Thursday.

Many City economists expect the Bank to raise rates by 0.25 per cent, in order to avoid breaching the upper limit of 3.5 per cent in the Government's inflation target in the future.

If inflation rises by more than 1 per cent above the central target rate of 2.5 per cent, the Governor of the Bank has to write to the Chancellor of the Exchequer giving an explanation.

But Professor Minford said he did not believe the Bank would risk further market turbulence by raising rates. "After the stock market drop you've got the risk of overkill. Exchange rates are also high that a rise in interest rates could trigger further falls in share prices."

The FTSE 100 index ended last week 127.9 points lower at 5330.8, having recovered some of its lost ground after a 458 point plunge at one stage on Tuesday. Despite the turmoil, some City economists have urged against loosening monetary policy to settle the markets, a mistake made by policymakers after the crash of 1987.

The group of monetarists, which met before the crash, said rates would have to rise in the future to meet the inflation target, though in the short term the strength of the pound would have a dampening effect on economic activity.

Professor Minford said he believed the UK economy had "peaked", with consumer spending growth slowing as the impact of building society windfall bonuses ebbed, despite continuing strong growth in the money supply.

However, others on the committee warned that share and property prices were rising to unsustainable levels, as they did at the peak of the booms in the early 1970s and later 1980s.

Meanwhile, Gordon Brown, the Chancellor of the Exchequer, yesterday reaffirmed his commitment to keep the pound out of the exchange rate mechanism (ERM) before the UK joins European economic and monetary union. "We have no intention of entering the ERM," Mr Brown said on BBC television.