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Share shock likely to leave rates on hold

Interest rates are unlikely to rise on either side of the Atlantic before the new year, following last week's sharp drop in share prices. But analysts predicted at the weekend that stock markets were likely to remain unsettled for the rest of this year.

Kenneth Clarke, Chancellor of the Exchequer, is due to reply to MPs' questions on the Budget today, ahead of his monthly meeting on Wednesday with Eddie George, Governor of the Bank of England.

Although the two men will have preliminary figures for November retail prices, expected to show another increase in the annual inflation rate, remarks the Governor made last week suggested he will not be pressing for the next base rate increase so soon after the Budget.

The Bank has said that the strength of demand points to the need for higher interest rates at some stage, but Mr George played down financial market fears about the pressures.

Similarly, the US Federal Reserve is not expected to increase US interest rates at the 17 December meeting of its policy committee, even though the US economy will probably be showing fresh signs of strength.

Fed chairman Alan Greenspan provoked Friday's share sell-off by referring to the stock market's "irrational exuberance", in a speech which most Fed-watchers interpreted as a deliberate bid to cool Wall Street's high temperature.

"Unless the economy roars into the new year, the Fed is unlikely to tighten policy. The jitters in the financial markets will probably blow over fairly quickly," said Mark Cliffe of HSBC Markets.

Steven Bell, chief economist at Deutsche Morgan Grenfell, said: "The history of sell-offs like Friday's is that they get reversed. Even so, there will be further falls. When we get evidence of stronger growth and higher interest rates, that will happen."

Even without new economic evidence, Wall Street and the US bond market are likely to be hit by year-end profit-taking by the giant mutual funds.

These are sitting on enormous paper profits, and Friday's dive will encourage them to lock in their results before the Christmas holiday.

In addition, most funds change their portfolio positions by taking big positions in the futures markets around new year. This too could lead to more upsets during the next few weeks, according to Goldman Sachs equity strategist Abby Cohen.

The US economy has so far combined steady growth with low inflation. Figures on Friday showed a smaller-than-expected rise in the number of new jobs last month but a sharp increase in hourly earnings. This week's consumer price figures are likely to show inflation picking up above 3 per cent. Economists expect figures on Thursday to show the UK's annual headline rate of inflation remaining above 3 per cent.

A survey published this morning by the Engineering Employers' Federation shows that pay settlements in the industry have remained steady at an average of 3 per cent.

David Yeandle, head of employment affairs, welcomed this prudence, saying: "We are encouraged to see that pay settlements in the industry are stable."

On the other hand, the signs of the consumer spree continue to build up. A survey by property consultants Healey & Baker, also released this morning, estimates that consumers will spend pounds 23.5bn on Christmas this year, a pounds 700m increase over last year.