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Manufacturing output weaker

Economy: Poor figures boost expectations Governor will not push for higher interest rates today

Economics Correspondent

Britain's manufacturing output fell in July, taking it below its level at the end of last year. The news boosted expectations that Eddie George, the Governor of the Bank of England, will withdraw earlier advice to raise base rates at today's monthly monetary meeting with Chancellor Kenneth Clarke. Financial markets now think rates will fall before Christmas.

This expectation helped share prices in London close at a new record high yesterday. The FT-SE 100 index ended at 3,557.7, up 25 points in the day.

Most City of London economists think today's meeting between Mr Clarke and Mr George will not end with a decision to cut rates. But after yesterday's figures, the Governor is likely to retreat from his view rates should rise.''It would be dangerously reckless for the Bank to continue recommending a rate rise after these data,'' said Simon Briscoe, an economist at Nikko Europe.

Manufacturing output fell 0.4 per cent in July from June, and rose 0.2 per cent in the three months to July compared with the previous three months. Over the three months, it fell 0.1 per cent. Despite this disappointing performance, economists are split over the next move in rates. There is no agreement the economy is on the brink of returning to recession.

Sean Shepley, at investment bank Credit Suisse First Boston, said: ''Output has been weak all summer because firms are working off excess stocks. This could be quite a speedy process, but it means inflationary pressures have ground to a halt.''

Other recent statistics have echoed the weakness in industry. Claimant unemployment rose in July for the first time in nearly two years. Retail sales recovered but were still only 1.4 per cent higher than the previous July. Surveys by the Confederation of British Industry and Chartered Institute of Purchasing and Supply suggest the slowdown in industry will continue into the autumn, orders down from earlier high levels.

The black cloud over the housing market shows no sign of dispersing. Such is the gloom that mortgage lenders have spontaneously cut their rates.

Yet the debate over the direction of interest rates - which the Chancellor has described as ''finely balanced'' since he first turned down the Governor's advice to raise them in May - has not tilted definitively in favour of a cut. Apart from the fact that inflation remains above its target, monetary indicators have remained buoyant. In addition, many economists think growth will pick up before the end of the year. Interest rate cuts overseas will help export markets.

David Hillier at NatWest markets, said: ''This slowdown has been engineered and we have ended up exactly where we were meant to be. The Governor will retreat in order to keep his powder dry if a rate rise is needed in the New Year.''

Comment page 17

Still finely balanced?

The case for a cut in base rates

o Manufacturing output has stalled. Other measures of activitity such as GDP and unemployment suggest economic growth has slowed.

o The housing market is still in decline, casting a shadow over consumer spending.

o The boom in commodity prices, which fed through to factory gate inflation, is over.

o Both US and German interest rates have fallen recently, and Japan is expected to cut rates this month.

o The pound has recovered from its May low-point (the sterling index touched 82.7 against other currencies and is back to 84.8).

o Financial markets expect a cut before the new year, and would react favourably.

The case against a cut in base rates

o The economy was meant to slow from an unsustainably high rate of growth. Fears of recession are premature.

o Inflation excluding mortgage interest payments is above its 2.5 per cent target, reaching 2.8 per cent in July.

o Pay settlements have started to climb. This week has brought warnings on pay from Industrial Relations Services, whose survey is monitored by the Treasury, and engineering employers.

o Money supply measures and bank lending have been growing rapidly.

o Tax cuts in the Budget on 29 November would stimulate the economy. City economists expect cuts worth pounds 2-4bn.

o The pound is still nearly 5 per cent lower than at the start of this year (its index stood at 89.0 on 1 January).