Slowdown paves way for rate cut

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The Independent Online

Economics Correspondent

Minutes of the last-but-one meeting between Kenneth Clarke, Chancellor of the Exchequer, and Eddie George, Governor of the Bank of England, published yesterday paved the way for further cuts in base rates in the new year, City economists said.

The minutes showed that Mr George expressed concern at the monetary meeting on 1 November that costs and prices were higher than he had hoped. Yet so strong was the evidence of slower growth by the time of the next meeting on 13 December that the Governor had changed his mind and recommended the quarter-point cut in base rates to 6.5 per cent.

At the beginning of last month, according to the minutes, Mr George said the recent data had been "uncomfortable". Cost and price figures were stronger, while activity figures and surveys were weaker than hoped. The uncertainties about both had increased.

Mr George said at the meeting that: "The main issue was whether the current indications of weakness were temporary or whether they were likely to persist." The Bank believed activity would pick up, but there were risks it would not.

The minutes report that: "In the circumstances, he would not wish to argue for any change in the policy stance until things had become rather clearer." The Chancellor agreed that there was nothing new that would justify a change in interest rates.

Mr George's wait-and-see advice came just before publication of the Bank's quarterly Inflation Report, which forecast that inflation would remain a little above the 2.5 per cent target in two years. However, the economic statistics for October and November released subsequently showed a further slowdown in growth and a fall in inflation. In particular, the estimate of GDP in the third quarter was cut to 0.4 per cent.

Don Smith, an economist at HSBC Markets, said: "A lot happened between the beginning of November and the middle of December. It became very apparent that inflation pressures were receding."

The neutral Budget would also have made the Governor more relaxed about a fall in base rates, he said.

The minutes showed Mr Clarke to be concerned about pay pressures. He said the behaviour of the labour market would be important for the future path of inflation.

However, his worries were muted. "Falling unemployment did not appear to have put upwards pressure on earnings, in part because of the labour market reforms the Government had put in place."

Mr George had earlier highlighted the importance of trends in wages in his post-Budget evidence to MPs on the Treasury Select Committee.

The minutes pointed out that in sectors where profits had been high pay settlements could be higher than average, and there was a possibility that these could act as a benchmark for awards elsewhere. This probably reflected fears that the negotiations then starting at Ford and Vauxhall could set an increased "going rate".

The Chancellor and Governor concluded that this influence was likely to be limited. But economists yesterday said concern about pay pressures might delay the next cut in base rates until February or March, when there was more evidence about settlements in the current pay round. January is the most important month for wage settlements.

Helen MacFarlane, an economist at brokers Hoare Govett, said: "The labour market is the key to inflation. Average earnings have been remarkably well-behaved, but they could pick up in the early part of 1996."

Mr Clarke and Mr George are due to meet on 17 January. Financial markets yesterday signalled the expectation that base rates will fall another quarter point before the end of March and a similar amount by mid-year.

There was almost no market reaction to the Bank of England's announcement of the schedule of gilt auctions for the first quarter of 1996. The Bank will sell pounds 13.8bn of gilts in three auctions, the first on 23 January. The February auction will extend the maturity range of gilts in issue with a stock maturing in 2020 or later. Results of two of the three most recent auctions have disappointed.