Shares drop as inflation fuels rate fears

SHARE and gilts prices dropped sharply yesterday as an unexpected rise in inflation fuelled fears that Monday's rise in interest rates would be the first of many.

Inflation rose from 2.3 per cent in July to 2.4 per cent in August, as price cuts in the summer sales were reversed and prices for petrol and non-seasonal foods increased. The Government's target measure of underlying inflation - excluding mortgage interest payments - rose from 2.2 to 2.3 per cent, the Central Statistical Office said.

The summer sales this year have been of similar magnitude to those last year, but later and packed into a shorter period. Clothes prices recorded their biggest August rise since 1918, following their biggest July fall since 1914. Household goods prices followed a similar pattern. It remains to be seen to what degree the recovery from sale prices continues in September.

Don Smith, analyst at HSBC Greenwell, said that retailers may have been over-optimistic in the prices they were setting for autumn stock. 'If the CBI survey is right, then retailers had a dismal month and this implies that higher, post-summer sales prices cannot be sustained'.

Food prices rose by 0.3 per cent in August, with very sharp rises in potato prices overwhelming those of other fruit and vegetables. Household goods prices rose by 1.6 per cent and clothing and footwear prices by 2.2 per cent. The impact of higher mortgage rates will not feed into the retail price index until October, with the size of the effect unclear until more lenders have decided whether to change their rates.

The markets were unnerved by the figures, with the FT-SE index of 100 leading London shares falling 41.6 points to 3,079.8 and gilts prices dropping sharply. The short sterling futures contract ended the day predicting a further rise in base rates by the year-end.

The markets paid little attention to the US retail sales figures, which showed a rise of 0.8 per cent last month, a little less than expected. Excluding cars, retail sales were slightly stronger than expected.

Dealers were also spooked by the news that the Chancellor of the Exchequer had been given a preliminary estimate of inflation at 5pm last Wednesday, after his meeting with the Governor of the Bank of England but before the decision to raise rates was taken on Friday. Some analysts said the Chancellor had been pushed into the move by bad inflation news, although he responded that it had not influenced his decision.

There was better news for inflation from the Department of Employment, which reported that the underlying rise in average earnings over the year to July was unchanged at 3.75 per cent. The rate of increase in manufacturing fell from 4.25 to 4 per cent.

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