Shares put on pounds 11bn as pound takes a beating in New York and Toky o
But a survey showing service industries booming in the final quarter of last year as manufacturing struggled under the burden of the strong currency emphasised the dilemma over whether or not the Chancellor should raise interest rates.
The British Chambers of Commerce, like the CBI earlier this week, urged Mr Clarke against this. Commenting on its quarterly survey of business, the BCC deputy director general, Ian Peters, said: "It is important for the performance of manufacturers, and particularly the larger ones, that we don't risk snuffing out the manufacturing recovery by increasing interest rates at this stage."
The pound fell sharply in New York and Tokyo overnight before settling during yesterday's trading in London. The finger of suspicion pointed at hedge funds run by speculators such as George Soros.
A spokesman for Mr Soros said his fund never commented on its investment policies, but traders said there had been widespread sales of sterling by big investors to take profits after the currency's strong gains.
Paul Meggyesi, an analyst at Deutsche Morgan Grenfell, said: "Sterling corrections, when they happen, are short and nasty. Once the dam breaks, the flows are huge."
The sterling index against other currencies closed 1.4 points lower at 95.8 yesterday. The pound lost nearly 5 pfennigs, falling to DM2.6685, and declined more than two cents to $1.6278. It closed half-a-cent lower at $1.6313 in New York. The FTSE 100 index gained more than 52 points to close at 4,271.5, aided by a buoyant start on Wall Street - although the Dow Jones Industrial Average finally ended down 94 at 6,755 - as the financial markets stuck to their assessment that Mr Clarke can avoid having to increase the cost of borrowing.
Big exporters were among the best performers as they stand to gain most from the drop in sterling.
Explaining his decision earlier this month to leave rates unchanged in the face of the Bank's advice, the Chancellor dwelt on the strong pound's impact on industry.
But analysts did not yet expect the setback to sterling to weaken the Chancellor's resistance to Bank of England advice in favour of higher base rates, although the Treasury had no comment. As one official remarked: "We don't talk about the pound on the way up, and we don't talk about it on the way down."
A survey of more than 8,600 companies showed that manufacturing orders fell in the final quarter of 1996 and output growth stalled. Although reported business confidence in the sector increased, firms reported planned cuts in investment and employment.
"The strong pound is becoming a serious issue for manufacturers," Mr Peters said. Of the big companies taking part in the survey, 95 per cent said the rise in sterling - of about 8 per cent between the summer and the end of last year - was hindering their business. The pound had climbed as much again between the new year and the start of this week.
On the other hand, the indicators for the service sector were at the highest since the survey began in 1989. Confidence, home and export orders, employment and investment all increased. Most significant in terms of inflationary pressures, service companies reported increased recruitment difficulties and expressed concern about rising pay awards.
"There are clear signs the service sector is overheating," said David Mackie, UK economist at investment bank JP Morgan. "This highlights the dilemma about interest rates.You can come out with whatever policy prescription you want to."
Following a series of weaker-than-expected economic statistics since the new year, many financial analysts had revised their view that strong growth would force Mr Clarke to follow up October's quarter-point rise in base rates with a second increase. The pound lost ground to the dollar as a result, but its exchange rate against other currencies did not catch up until yesterday.
"This was a fall waiting to happen," said Chris Turner, currency analyst at BZW.
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