Inflation dip helps Clarke maintain rates

The Chancellor of the Exchequer left interest rates unchanged yesterday, following his Wednesday afternoon meeting with the Governor of the Bank of England. His decision was reinforced by figures showing that the inflation rate edged lower last month.

The financial markets reacted with exuberance. The FTSE 100 index jumped nearly 39 points to close at 4,197.5, a new record. The pound fell briefly when it became clear base rates were not going to rise, but ended the day almost unchanged at DM2.6673.

Mr Clarke emphasised the rise in sterling during recent months as a factor in his decision. "The big thing at the moment is the pound is very strong, and that is very anti-inflationary," he said.

The Chancellor also referred to the evidence on industrial output and Christmas shopping, both a bit weaker than expected.

Yesterday's figures showed that the Government's target measure of inflation, the retail price index excluding mortgage interest payments, fell in December for the first time since May. It declined from 3.3 per cent to 3.1 per cent, compared with the 2.5 per cent target.

The headline rate fell to 2.5 per cent from 2.7 per cent in November.

"These figures show that subdued cost pressures and a stronger pound are feeding through to lower inflation," the Chancellor said.

Analysts were divided in their reactions. Optimists concluded that Mr Clarke would be able to hold off any increase in the cost of borrowing before the election.

"These figures will lay to rest the fears that stronger retail demand is leading to higher prices," said Simon Briscoe, an economist at Nikko. Michael Saunders at investment bank Salomon Brothers agreed. "If sterling remains strong it is possible that rates will be left unchanged," he said.

Others said the strength of the economy meant the longer-term inflation outlook was less favourable. David Walton at Goldman Sachs predicted that it would rise to 4 per cent in 1998 after hitting the target measure briefly later this year.

Part of the explanation for last month's fall in inflation was the comparison with a strong rise in prices, especially for food, 12 months earlier.

In addition, petrol prices fell before tax, while retailers appeared to have passed on only about half of the duty increase announced in the Budget. There were also falls in the prices of some high-street goods such as clothing and footwear and household appliances.

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