Mixed signals deepen rates dilemma

THE GOVERMENT's dilemma over how far and how fast to cut interest rates will today be deepened by conflicting evidence over the state of the economy.

Manufacturing output may be set to decline further, according to the latest purchasing managers' survey from the Chartered Institute of Purchasing and Supply. But a study of 1,000 companies by 3i, the venture group, reveals business confidence at its highest for more than four years.

The latest purchasing managers' index, based on such factors as new orders, output and employment, was unchanged in January at 49.3 per cent. The institute said: 'A reading below 50 per cent implies a decline in manufacturing industry for the seventh month in succession.'

The UK index, using techniques developed by the authoritative US National Association of Purchasing Management, is based on a survey of purchasers accounting for more than pounds 250bn of corporate spending annually. It also points to falling employment levels.

A breakdown of the composite index suggests that raw material prices rose sharply following the devaluation of the pound last September. Devaluation also helped exports, with new orders rising above 50 per cent and several purchasers referring to export orders. But if seasonal factors were excluded, the institute said, the index suggested there might have been a small rise in manufacturing output in January.

A separate poll of more than 1,000 companies by 3i, also published today, says that business confidence has improved sharply.

The poll reveals that business confidence swung to a positive balance of 73 from the minus four registered in September, its highest reading since September 1988. It follows other recent polls disclosing a sharp surge in confidence.

The 3i poll was reinforced by Infolink, the UK's largest independent credit information organisation, which said consumer credit inquiries rose in December for the third month running, and may indicate a further recovery into the new year.

The latest three months are in contrast to the generally unpredictable changes in credit demand during much of 1992.

But Brian Bailey, Infolink chairman, warned: 'It is hoped that credit will continue to grow into the new year, but the outlook for 1993 continues to remain uncertain, with unemployment still the greatest consumer constraint against economic recovery in the long term.'

Without such a significant pick-up in the economy - and so in tax revenues - the City widely expects the Government to have difficulty in funding its borrowing requirements. At prevailing UK interest rates, sales of government securities - gilts - are widely held to be relatively unattractive internationally.

The Bank of England is understood to have become sufficiently concerned to have urged the Treasury to abandon its policy of fully funding the budget deficit. It wants it to take a more pragmatic approach to financing the public sector borrowing requirement. The issue was raised on 13 January, at the most recent monthly meeting on monetary issues between the Bank and the Treasury. Those at the meeting included Norman Lamont, the Chancellor, and Robin Leigh-Pemberton, the Governor of the Bank of England.

The full funding policy says that the entire public sector borrowing requirement - the PSBR - must be financed largely by sales of gilt-edged stock to the private sector, excluding banks, during the year in which it occurs. It has now been placed under review.

Any changes to the system, which was vigorously defended by the Chancellor and his officials in evidence to the Treasury and Civil Service Select Committee last autumn, will be announced in the Budget on 16 March. The issue has acquired fresh urgency in view of the expected scale of public borrowing over the next few years. It far exceeds the proportion of institutional cash flow traditionally invested in gilts and implies a heavy reliance on foreign investment in UK government bonds.

Last week's badly received auction of pounds 2.5bn of gilts suggests uncertainty about the market's willingness to absorb new issues on the required scale - pounds 1bn a week for the foreseeable future.

However, in a study published today Nomura Research Institute challenges the view that there are insufficient institutional funds to finance the PSBR.

It says what matters is not the expected pounds 40bn of institutional cash flow, but the stock of institutional assets, which it puts at pounds 1,000bn.

Gavyn Davies, page 21