Concerns that the economic outlook might not be as gloomy as feared hit interest rate hopes and sent financial markets lower yesterday. Gilts and shares in London ended lower, following the lead set by the US and Germany.
Remarks by Howard Davies, Deputy Governor of the Bank of England, that growth as high as 3 per cent this year was ''well within the realms of possibility'' followed figures showing the narrow money supply was slightly more buoyant than expected last month.
City analysts do not expect the Chancellor to reduce base rates after his meeting with the Governor of the Bank of England tomorrow after two moves in the past two months, but are still betting on one more quarter point reduction from the current level of 6.25 per cent before midsummer.
Gilts ended more than a point lower in heavy trading, while the FT-SE 100 index closed down nearly 35 points at 3746.6.
A weak performance by German government bonds yesterday also affected gilts. The bund market fell after figures showing an increase in German output for the second month running in December.
US Treasuries echoed the weakness in European markets, overshadowed by the prospect of record sales of bonds due this week. The Treasury is scheduled to auction $44.5bn-worth between today and Friday. The dollar fell below Yen105 due to uncertainty about Japanese buyers' interest in the auction. It was down more than a pfennig at DM1.4625.
Cash in circulation in the UK rose more than expected in January, even though a big drop in banks' balances held at the Bank of England meant the overall growth of the narrow money measure, M0, dipped.
Narrow money fell 0.2 per cent during the month due to this pounds 128m decline in bankers' balances, following a 0.9 per cent jump in December. M0's annual growth fell to 5.3 per cent from 5.7 per cent.
There was a 0.3 per cent rise in notes and coin in circulation last month, taking its year-on-year growth to 5.7 per cent - similar to its rate of growth in the previous six months.
The Bank of England warned that adjustment for seasonal variation was difficult over Christmas and New Year. Robert Barrie, UK economist at BZW, said: ''Taking the two months together, the figures point to steady growth.''
An article on interpreting the money supply due in the Bank of England's Quarterly Bulletin next week is expected to show that narrow money is a good forward indicator of the economy's performance.
Separate figures from department store and supermarket group John Lewis provided additional evidence that retail sales were not unduly weak last month. It reported that sales were running about 10 per cent higher than a year earlier.
However, new housing starts remained weak in December, and were 15 per cent lower in 1995 than the previous year.
Germany's industrial output rose 0.6 per cent in December, following a 0.9 per cent rise the previous month, a better performance than expected. Economist Robert Prior-Wandesforde at James Capel said: ''There is some tentative hope that the worst of the slowdown in Germany may be behind us.''