Rate cut leaves markets expecting rise within a year

The unexpected fall in base rates yesterday sent the pound lower and left the financial markets betting that rates will have to rise again within the next 12 months.

On a day that brought additional evidence that the economy is picking up, City reaction to Kenneth Clarke's surprise was mixed. Many analysts argued that it was a political move and likely to have been opposed by Eddie George, Governor of the Bank of England.

''The Bank of England warned that this is just the stage of the cycle when mixed signals on the economy mean policy-makers make mistakes. Mr Clarke should not have cut interest rates,'' said James Barty, UK economist at the investment bank Deutsche Morgan Grenfell.

David Walton at Goldman Sachs said the Governor probably accepted the case for a cut in the short term but would have warned that base rates might have to go up again later. ''It does leave a nagging doubt that the politics is coming into play,'' he said.

Geoffrey Dicks, an economist at NatWest Markets, noting that Mr Clarke had promised to raise rates later if necessary, said: ''We are ready to hold the Chancellor to his word.''

Speaking about its Inflation Report last month, Mervyn King, the Bank's chief economist, said he saw no need for the extra insurance against short- term economic slowdown that another base rate reduction would bring. The report predicted a small risk that inflation would be above its 2.5 per cent target in 1998.

However, recent figures showing continuing recession in manufacturing industry, combined with the strength of the pound, allowed Mr Clarke to make out a good case for reducing the cost of borrowing. ''I am satisfied that this modest further cut in interest rates is fully consistent with my target of inflation below 2.5 per cent,'' he said yesterday.

The Chancellor's panel of ''wise persons'' lent some support to this view. In a special report on the ''output gap'' coincidentally published yesterday morning, they concluded that the economy had room to grow at a faster rate than normal for three to five years without causing a rise in underlying inflation.

Even so, some of the panel's members had doubts about the latest reduction. Martin Weale of the National Institute of Economic and Social Research said: ''If there is an economic justification for yesterday's rate cut, it is the rise in the exchange rate. But will the Chancellor put rates up again if necessary? Probably not.''

Sterling's index against a range of other currencies has gained 5 per cent this year. According to the Treasury's rule of thumb, this is equivalent in effect to an increase of more than 1 per cent in base rates. The higher pound will help reduce already weak inflationary pressure.

Roger Bootle, chief economist at HSBC Markets, predicted that base rates will have to fall even further to offset the impact of the strong currency on manufacturing.

Simon Briscoe at the Japanese bank Nikko agreed: ''There can be little doubt after this move that if the economy is weak in the next couple of months the Chancellor will be prepared to cut rates.''

However, yesterday's economic statistics provided more evidence for a healthy pace of economic recovery. Last month saw the eighth successive annual increase in the volume of retail sales, according to the CBI's survey of the distributive trades.

The pace of growth was a little slower than April, and less than expected. However, retailers' optimism about future sales returned to its highest since December 1988, despite the fact that their recent expectations have been consistently disappointed.

Alastair Eperon, chairman of the CBI's distributive trades panel, welcomed the emergence of a ''feel-better mood" among consumers.

Estate agents Black Horse brought news of a property shortage as thousands of potential buyers re-entered the housing arena. It said 43 per cent of its offices had reported a shortage of three- or four-bedroom semi- detached houses.

David Wood, managing director, said: "Buyers are obviously judging now as the right time to re-enter the market, or buy for the first time.''

According to the Halifax's figures, house prices have climbed at an annualised rate of 12 per cent so far this year.

Separate figures from the Society of Motor Manufacturers and Traders (SMMT) yesterday showed that new car registrations last month were 8.5 per cent higher than a year earlier. The SMMT was particularly encouraged by a sharp rise in retail purchases.

Venture capitalists 3i reported that optimism among small and medium- sized companies had risen for the second quarter running, especially those not involved in manufacturing.

In addition, the number of companies going into receivership rose between April and May but was a third lower than a year earlier, according to accountancy firm Deloitte and Touche. There was a particularly significant drop in the South-east.

Treasury officials and ministers hold their annual Dorneywood meeting this weekend to kick off discussions of this year's Budget strategy. The Chancellor is due to give his Mansion House speech, traditionally on monetary policy, next Wednesday.

Sterling lost more than a pfennig in value against the mark yesterday, closing at DM2.3580. The short sterling futures market soared, but continued to point to base rates back near 7 per cent a year from now.

Comment, page 17

Suggested Topics
Start your day with The Independent, sign up for daily news emails
ebooks
ebooksAn introduction to the ground rules of British democracy
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
SPONSORED FEATURES
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

SThree: Experienced Recruitment Consultant

£20000 - £40000 per annum + OTE + Incentives + Benefits: SThree: Established f...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE 40/45k + INCENTIVES + BENEFITS: SThree: The su...

Recruitment Genius: Collections Agent

£14000 - £16000 per annum: Recruitment Genius: This company was established in...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE 40k: SThree: SThree are a global FTSE 250 busi...

Day In a Page

Refugee crisis: David Cameron lowered the flag for the dead king of Saudi Arabia - will he do the same honour for little Aylan Kurdi?

Cameron lowered the flag for the dead king of Saudi Arabia...

But will he do the same honour for little Aylan Kurdi, asks Robert Fisk
Our leaders lack courage in this refugee crisis. We are shamed by our European neighbours

Our leaders lack courage in this refugee crisis. We are shamed by our European neighbours

Humanity must be at the heart of politics, says Jeremy Corbyn
Joe Biden's 'tease tour': Could the US Vice-President be testing the water for a presidential run?

Joe Biden's 'tease tour'

Could the US Vice-President be testing the water for a presidential run?
Britain's 24-hour culture: With the 'leisured society' a distant dream we're working longer and less regular hours than ever

Britain's 24-hour culture

With the 'leisured society' a distant dream we're working longer and less regular hours than ever
Diplomacy board game: Treachery is the way to win - which makes it just like the real thing

The addictive nature of Diplomacy

Bullying, betrayal, aggression – it may be just a board game, but the family that plays Diplomacy may never look at each other in the same way again
Lady Chatterley's Lover: Racy underwear for fans of DH Lawrence's equally racy tome

Fashion: Ooh, Lady Chatterley!

Take inspiration from DH Lawrence's racy tome with equally racy underwear
8 best children's clocks

Tick-tock: 8 best children's clocks

Whether you’re teaching them to tell the time or putting the finishing touches to a nursery, there’s a ticker for that
Charlie Austin: Queens Park Rangers striker says ‘If the move is not right, I’m not going’

Charlie Austin: ‘If the move is not right, I’m not going’

After hitting 18 goals in the Premier League last season, the QPR striker was the great non-deal of transfer deadline day. But he says he'd preferred another shot at promotion
Isis profits from destruction of antiquities by selling relics to dealers - and then blowing up the buildings they come from to conceal the evidence of looting

How Isis profits from destruction of antiquities

Robert Fisk on the terrorist group's manipulation of the market to increase the price of artefacts
Labour leadership: Andy Burnham urges Jeremy Corbyn voters to think again in last-minute plea

'If we lose touch we’ll end up with two decades of the Tories'

In an exclusive interview, Andy Burnham urges Jeremy Corbyn voters to think again in last-minute plea
Tunisia fears its Arab Spring could be reversed as the new regime becomes as intolerant of dissent as its predecessor

The Arab Spring reversed

Tunisian protesters fear that a new law will whitewash corrupt businessmen and officials, but they are finding that the new regime is becoming as intolerant of dissent as its predecessor
King Arthur: Legendary figure was real and lived most of his life in Strathclyde, academic claims

Academic claims King Arthur was real - and reveals where he lived

Dr Andrew Breeze says the legendary figure did exist – but was a general, not a king
Who is Oliver Bonas and how has he captured middle-class hearts?

Who is Oliver Bonas?

It's the first high-street store to pay its staff the living wage, and it saw out the recession in style
Earth has 'lost more than half its trees' since humans first started cutting them down

Axe-wielding Man fells half the world’s trees – leaving us just 422 each

However, the number of trees may be eight times higher than previously thought
60 years of Scalextric: Model cars are now stuffed with as much tech as real ones

60 years of Scalextric

Model cars are now stuffed with as much tech as real ones