Inflation under control, says Clarke: Chancellor hails 'spectacular' fall to 26-year low but gives no clue on his future interest rate policy

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SUPERMARKET price wars helped to push the Government's target measure of underlying inflation to a 26-year low last month, keeping the door open for another cut in interest rates in the next few weeks.

Kenneth Clarke described the latest inflation figures as 'spectacular' and said inflation pressures 'seem pretty well under control'. A senior Downing Street official described them as 'excellent' and 'dramatic'.

But in testimony to the House of Commons Treasury Select Committee the Chancellor gave few clues on future interest rate policy.

The stock market roared ahead on hopes that the rate cut could still come before Christmas. The FT-SE index of 100 leading London shares rose 30.4 points to a record 3,278.8.

Retail prices fell by 0.1 per cent for the second successive month, leaving the headline rate of inflation unchanged at 1.4 per cent, according to the Central Statistical Office. Inflation was subdued by the sharpest cuts in non-seasonal food prices for three decades, lower car prices and pre-Christmas discounts for alcoholic drinks.

The headline inflation rate remained unchanged because a cut in mortgage interest rates a year earlier dropped out of the annual price comparison. But underlying inflation - excluding mortgage interest payments - fell unexpectedly sharply from 2.8 to 2.5 per cent. This was the lowest rate of underlying inflation since 1967.

The Chancellor expressed optimism that the Treasury's 1-4 per cent target range for underlying inflation would not be breached. 'I feel pretty confident that we are not going to get into trouble with our inflation target in the near future.'

Mr Clarke indicated that his comments also applied to the upward pressure on inflation from Budget tax increases, and he ruled out redefining the target to eliminate the impact of indirect taxes.

The Chancellor added that his concern was over future inflation trends: 'What matters is where it is going to be from now on.'

He acknowledged that the tax increases resulting from the March and November Budgets - the equivalent of 7p in the pounds on the basic rate of income tax - were bound to slow the recovery. But he believed the economy was strong enough to withstand the impact. Without the tightening fiscal policy to curb the pounds 50bn public sector borrowing requirement, the Chancellor said, the recovery was 'less likely to be sustained'. He stressed that he had chosen tax increases that would have the minimum adverse impact on the economy and rejected charges that he was putting the squeeze on the middle classes.

The rate of inflation for household goods prices fell to 0.9 per cent, the lowest since records began in 1974. Household goods prices fell for the first time in 11 months, reflecting the low numbers of people moving house.

Price-cutting in the shops has helped to buoy spending volumes. Retail sales volume rose by 0.4 per cent in November, at the more optimistic end of City forecasts. Spending averaged pounds 3.1bn a week, rising from pounds 2.9bn a week in October as Christmas drew closer. Trade was stronger than suggested by the Confederation of British Industry's latest survey of retailers.

Food sales rose by 0.5 per cent, in part reflecting the price wars. Department store sales rose by 1.1 per cent, as they continued to take market share from smaller outlets. But household goods sales fell.

Commenting on the Bank of England's autonomy in the timing of interest rate changes, the Chancellor said the move was designed as a symbol that rate changes were made for monetary and economic purposes rather than political ones.

But Mr Clarke agreed with recent testimony by Eddie George, Governor of the Bank that a disagreement between the Bank and the Treasury over interest rate changes would find its way into the Bank's independently written inflation report. 'It is perfectly possible that Eddie George and I will reach a stage where we do start to disagree,' he said.

Asked about factors that influenced interest rate changes, the Chancellor said he placed weight on exchange-rate stability but did not have a target. He expressed relief that European countries had not resorted to competitive devaluations in the wake of the collapse of the exchange rate mechanism.

Latest figures in the US suggest that manufacturing industry there is enjoying a firm recovery. Industrial production rose by 0.9 per cent in the month, the sixth successive rise, according to the Federal Reserve.

John Watts, chairman of the Treasury select committee, announced that it will investigate regulation of the financial services industry. The move comes after recent disclosures that hundreds of thousands of people may have been wrongly advised to transfer their savings out of company-run pension schemes into private arrangements.

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