High street surge makes rate rise likely

The fourth increase in the cost of borrowing in as many months looked increasingly on the cards after new figures yesterday showed the biggest surge in high street spending since the late-1980s boom.

The prospect of a further increase in interest rates by the Bank of England drove the pound to its highest level for more than eight years, to the dismay of exporters. Its index against a range of other currencies leapt a full point to 106.7.

The Chancellor of the Exchequer came in for renewed criticism from City experts for having failed to crack down on windfall spending in the Budget, putting all the burden of cooling the economy on interest rates. "The Bank's policy dilemma intensifies by the hour," said Kevin Darlington at Hoare Govett."

But Eddie George, Governor of the Bank of England, backed the Chancellor. Speaking to MPs on the Treasury Select Committee, he denied that Gordon Brown's unwillingness to target the consumer in the Budget was the main reason for the recent rise of sterling. Rather, he said fears about European Monetary Union were the main cause.

"If you actually look at the timing of the upsurges ... against the core European currencies, they are mostly associated with developments on the Continent of Europe which are feeding this perception that the EMU process is now being driven by politics rather than on the basis of sound economics," he said.

The Prime Minister blamed the last Government for the dilemma. "Interest rates have had to go up because the previous Government failed to take the action necessary," Mr Blair said.

Despite the interest rate fears, the stock market made gains as share prices in the US surged for a second day. The FTSE 100 index was showing a bit of "irrational exuberance," Mr George said. It ended nearly 28 points higher at 4,874.5 after Wall Street had breached the 8,100 barrier in early trading yesterday.

Official figures showed that the volume of retail sales jumped 0.6 per cent last month even though it was the wettest June for a century. This would normally have depressed sales, but with consumers receiving pounds 20bn of free building society shares during the month, the Office for National Statistics said the windfall gains had contributed to a leap in purchases of household goods.

This rose by 7.5 per cent in volume terms, and stood 21 per cent higher than a year earlier. The increase in the past three months was, at 6.2 per cent, the highest recorded since the figures start in 1986.

The ONS suggested that the windfalls had added an extra pounds 150m to sales of household goods in June. This excludes spending on items like cars and holidays, which are recorded separately.

Sally Collinson of the Oxford Street Association, which represents local retailers and hotels, said sales had boomed, with windfall-related spending offsetting lower spending by tourists constrained by the strong pound. Spending had been strongest in areas such as carpets and curtains. "We think it's the windfall factor," she said.

Comet, the electrical retailer, yesterday backed up recent comments from Dixons when it said sales of televisions, hi-fis and PCs had risen significantly since the Halifax flotation at the beginning of June.

A drop in food sales kept the overall annual increase at 5.4 per cent. Even so, underlying growth in high street sales volumes was the highest since late 1988.

There were signs in the quarterly survey by the British Chambers of Commerce that the strength of the domestic economy is outweighing weaker export orders. Both manufacturers and service businesses reported increased domestic sales in the latest quarter, and both were creating new jobs.

"Consumer spending is building momentum. Once it picks up, it takes a lot to slow it down," said Kevin Gardiner, UK economist at Morgan Stanley.

Some economists drew comfort from the fact that the value of retail sales is growing slightly faster than the volume. But even optimists conceded an increase in rates from 6.75 per cent to 7 per cent was likely, with most predicting the move after the 6-7 August meeting of the Bank's Monetary Policy Committee.

Comment, page 21

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