Rate cut may have to wait for Budget

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The Independent Online

Economics Correspondent

Hopes for a reduction in base rates this week - raised by Friday's surprise mortgage rate cuts - are pinned on figures to be released before the Chancellor and the Governor meet on Thursday.

The mood in financial markets has shifted significantly to one of heightened expectation of a downward shift in interest rates, following the decisions by Abbey National, the bank, and the Northern Rock building society, to ease the cost of borrowing. Unusually, they did so without waiting for official rates to give them the lead.

Short sterling futures, which indicate expectations of interest rate movements, point to lower base rates already by the end of this month. But the Chancellor, Kenneth Clarke, and Eddie George, the governor of the Bank of England, will wait for industrial production figures on Wednesday to show how fast the economy grew in July.

Abbey National says the decision to cut its lending rate by 35 basis points to 7.99 per cent was prompted by its assessment that offical interest rates had peaked.

While many analysts concur that recent indicators suggesting a slowdown in the British economy will make it difficult for Mr George to insist on the need for another interest rate rise, few are willing to venture that a switch of the monetary policy points to rate reductions is imminent. There is a widespread view that a cut may have to wait until after the Budget in November.

Mervyn King, the Bank of England's chief economist, yesterday issued a veiled warning that the budget must be under control before being rewarded with rate cuts.

Speaking at a conference in the US, Mr King questioned whether deficit reductions would lead to lower real rates in small, open economies like the UK's. "Any central bank which cut short rates in anticipation of lower future real rates might well endanger its own credibility," he said.

To enhance their anti- inflation policies, Mr King suggested countries should introduce measures such as independent central banks, more transparent monetary policy-making, and the issuing of index- linked bonds.

Support for a less combative stance on interest rates comes today from the city economists at HSBC Markets, who argue that anti-inflation forces are as strong as ever. In a report published by the banking group, they say that inflation will fall back towards 2 per cent next year, safely under the Government's 2.5 per cent target.

The report acknowledges that the increse in retail price inflation since its trough last September has been disappointing, but argues that it reflects earlier cost pressures and is old news.

Increases in world commodity prices now appear to have passed their peak.

Gavyn Davies, page 17