Inflation figures dash hopes of rate cut to offset tax rise

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HOPES that Kenneth Clarke would sanction an early cut in interest rates to offset the depressing effect of next month's tax increases were dealt a severe blow yesterday by disappointing inflation figures.

The annual increase in the retail price index slowed to 2.4 per cent in the year to February, following a rise of 2.5 per cent in the year to January, according to the Central Statistical Office. Retail prices rose by 0.6 per cent between January and February alone, compared to 0.7 per cent last year.

The fading hopes of a rate cut depressed both gilts and equity prices. The benchmark 8 per cent gilt due 2003 closed pounds 20 32 lower at pounds 10320 32 , yielding 7.41 per cent.

Gilts had got off to a good start following the favourable reception in the US treasury market given to the Federal Reserve's announcement on Tuesday that it was raising US interest rates again. The Fed confirmed yesterday that the Fed Funds rate was being raised by a quarter-point to 3.5 per cent.

The Government's target measure of underlying inflation - excluding mortgage rates - was unchanged at 2.8 per cent last month, defying City predictions of a fall to 2.6 per cent. It is now at the rate forecast by the Bank of England in its last inflation report.

Footwear and clothing prices leapt by 2.7 per cent in February, the biggest increase for the time of year since 1941. This followed unprecedented price-cutting in the previous month. Prices for personal goods, such as spectacles, also rose sharply as sales came to an end. Food and second-hand car prices also increased.

Roger Bootle, chief economist at Midland Global Markets and a noted inflation optimist, said the British inflation figures were disappointing. However, he added that if next month's tax increases made consumers tighten their belts it would be difficult for retailers to maintain price rises.

'But it will still be very difficult for the Chancellor to cut base rates early. We will probably have to wait until July,' he added.

But Mr Clarke's interest rate dilemma was exacerbated by a promise from the Halifax building society to cut its mortgage rates if the Government cut interest rates to 5 per cent from their current 5.25 per cent. Most mortgage lenders did not cut rates for homeowners when base rates were cut on 8 February.

The European Commission said in its annual economic report, agreed yesterday, that Europe's interest rates should fall further. The report said recession in the EU was coming to an end, but that unemployment was expected to climb for another two years.

The key to lower interest rates is a sound outlook for inflation, the report added. That meant continued wage moderation, with pay increases below productivity increases.

Growth is predicted to be 1.3 per cent this year, rising to 2.1 per cent in 1995.