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Home sales dampen US rate cut hopes

Hopes of a cut in US interest rates at the Fed's meeting next week were knocked by figures showing unexpected strength in the economy. Dealers marked down Treasury bonds and the September T-bond future fell by well over a point.

The big surprise of the day was the number of new home sales in May in the US. These came in at a seasonally adjusted 722,000, the highest since March 1994 and well ahead of market expectations of about 595,000.

The monthly increase, the largest since January 1992, seemed to indicate that the dramatic plunge in US long-term rates this year was already reviving the economy.

Comments by John La Ware, the former Fed governor who left the Federal Reserve two months ago, did not help the mood in the markets. He said he expected "some pick-up in the second half" as lower market rates helped the housing market.

Further evidence that the slowdown in the US economy might be less serious than had been thought came with the latest indicator for unemployment. Initial jobless benefit claims in the past week were 368,000 - considerably lower than expected and the largest weekly decline for almost a year.

The new figures made the outcome of next week's meeting of the Federal Reserve open market committee even harder to predict.

Following recent remarks by Alan Greenspan, chairman of the Fed, in which he noted the possibility of "a moderate recession in the near term", markets had been anticipating a possible cut in rates. But yesterday's figures put a new gloss on what the Fed will decide to do.

John Shepperd, chief economist at Yamaichi International, said: "It will be a very close call." Nonetheless, he anticipates a possible cut of a quarter of a per cent to adjust monetary policy to the much weaker economic conditions that have emerged this year.

The jolt to market expectations in Wall Street had a knock- on effect on the London gilts market which had been bolstered in the morning by the successful auction by the Bank of England of pounds 2.5bn worth of stock. The September gilt future eventually closed a quarter of a point down on the day. The pound had a better day, with its value against a basket of currencies rising from a close of 83 on Wednesday to 83.4.

The Bank of England's auction of pounds 2.5bn worth of stock was far more successful than had seemed likely at the beginning of the week, when political uncertainty sent the gilts market into free fall.

But as John Shepperd, chief economist of Yamaichi International, pointed out, "the market had cheapened dramatically" in the past week, with September gilt futures down three points from their level last Thursday.

The issue of the 8.5 per cent 10-year benchmark stock was over-subscribed by a factor of two - a better cover than had been achieved in two earlier issues at the end of last year. The price achieved was 100.5, with an average accepted yield of 8.42. International investors stayed away, but domestic interest was high.

The auction brings the total volume of the stock to pounds 8.9bn.