No percentage in raising rates - Business - News - The Independent

No percentage in raising rates

Clifford German Personal Finance

DON'T shout it out loud just yet, but there is now just a chance that UK interest rates may not go higher, despite the uncertainty on currency markets - unless the Chancellor succumbs to pressure to play political games and raise rates now to prepare the way for tax cuts in November.

The danger point came after Kenneth Clarke and Eddie George held their monthly meeting last week. It was their first opportunity to assess the impact of the recent sharp fall in sterling against the mark. But the immediate inflationary impact of a weaker pound has been largely offset by the fall in the dollar, which has made even sterling look strong.

The American economy is showing distinct signs of overheating, but the Fed has also so far resisted pressure to raise interest rates again to protect the dollar. Even if US rates do rise, the UK might not have to follow suit - especially after the Germans took some heat out of the situation by cutting their interest rates 10 days ago.

Meanwhile, figures showing that UK industrial production and high-street spending have barely changed in recent months will ease fears that the surge in economic growth over the past year has been unsustainably fast and needs to be curbed to prevent industry running out of capacity. Factory output is only just back to 1990 levels, despite the export boom. Unemployment is still well above the level where labour shortages are likely to become serious, pay pressures are not obvious, and the latest round of tax increases that took effect last week should ensure that there is no great surge in consumer spending in the pipeline.

The housing market that has fed inflationary surges in the past is also showing no signs of life and posing no threat to financial stability.

There is no obvious internal reason at the moment why interest rates should go any higher at all, and every reason to believe that a further rise in rates now would create a severe blow to consumer confidence at a psychologically very damaging moment. It would trigger a further rise in mortgage rates, which could send a shockwave through the housing market and postpone the arrival of the feel-good factor indefinitely. It could tip the economy back into recession, not this year perhaps, but next.

Short of a currency crisis, the only possible reason for a further rise in interest rates right away would be to try to prepare the ground for an announcement of tax cuts in November. But the Chancellor must know that to risk stalling the economy just for the purpose of pulling off some spectacular fiscal aerobatics to impress the electorate would be a quite unnecessary risk both to the real economy and his own reputation - and one that would hardly pass without comment. And the markets could hardly turn a blind eye to tax cuts this year, when the borrowing requirement is still £30bn a year.

There is also good reason to believe that if the economy does stall it will take the best part of two years to revive it again, because of the inevitable time lags in the system. That would take us well past the last date for the election. A further rise in interest rates now could make any stall worse, but tax cuts announced this November would not guarantee a revival until after the election.

It is, however, quite possible that without further rate rises the economy will now coast for the next 18 months and still leave time for the Chancellor to announce modest tax cuts in November 1996.

If this is what the Chancellor himself is thinking, it means that variable- rate mortgages are a better bet than long-term fixed rates, and high-interest investments are well worth locking into, while shares could look under- valued again as soon as the market gets the message.

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