Interest rate verdict sends pound to three-year high against dollar

European Central Bank makes half-point cut as Duisenberg hints at more to come

Businesses were hit by a double whammy yesterday as the Bank of England refused to cut interest rates and the pound responded by hitting a three-year high against the dollar and rose against the euro.

The final meeting of the monetary policy committee chaired by Sir Edward George, who retires as Governor this month, left rates on hold at 3.75 per cent. The decision had been widely expected but was immediately condemned as a "lost opportunity" by business groups and trade unions.

"UK manufacturers will be disappointed," said Ian Brinkley, a senior economist at the TUC. "With so much economic uncertainty across the world a cut now would have given industry more confidence to invest."

David Frost, director general of the British Chambers Of Commerce, added: "The Bank has definitely missed an opportunity to offer extra support to UK business in a climate of weak demand at home and overseas."

Further ammunition for a rate cut came from a labour market survey that showed the number of permanent staff placed by recruitment agencies fell last month at the fastest rate since December 2001. Brett Walsh, of consultants Deloitte & Touche which co-sponsored the report, said: "It provides firm evidence of the absence of a post-Iraq bounce."

Economists in the City believe a cut may not be long in coming especially after April's split decision on rates. Philip Shaw, chief UK economist at Investec, said: "With some momentum already in place for [a cut] we expect a loss of patience with the pace of recovery to result in the MPC bringing rates down, perhaps as soon as July."

Businesses won a consolation prize in the form of a half-point cut in European interest rates that analysts said should boost demand for UK exports.

The European Central cut rates by a half-point to 2.0 per cent, the lowest level since the bank was set up in 1999, and its president Wim Duisenberg held out the hope of further cuts: "We have not exhausted our room for manoeuvre." The bank's move was partly driven by the surge in the euro against all the major world currencies, which is likely to cut prices of imports and curb demand for exports.

The decisive action and bearish comments from the ECB added further impetus to the surge in sterling that followed the Bank of England's verdict. Sterling hit its highest level against the dollar for three and half years, at one point touching $1.660, the highest since 26 October 1999. Yesterday's rate cut puts UK rates 1.75 percentage points above those for the euro area and 2.5 percentage points above the US.

David Bloom, a global economist at HSBC, said: "The pound has historically responded to interest rate differentials against the dollar."

The pound, which has fallen 8.5 per cent against the euro this year, gained slightly after the decision, reflecting lingering hopes of a rate cut. Philippe Legrain, the chief economist for the Britain in Europe campaign, said: "The fact that the Bank of England would have liked to have cut rates but was not able to because of the potential for the pound to fall shows we are suffering from being outside the eurozone."

Lehman Brothers, the Wall Street investment bank, published a major study on UK membership of the euro yesterday saying it would be a mistake to defer a referendum.

Gordon Brown, the Chancellor, is expected to say on Monday that his four of the five economic tests for entry have been failed. The bank's 60-page report said: "By putting off a referendum, the government is taking significant risks. The exchange rate is on the move and it could fall too far, hitting house prices and the consumer. That would dent the government's popularity - and affect its ability to win a referendum."