Kenneth Clarke cut interest rates yesterday by a quarter point to 6.25 per cent, in a surprise move that propelled the stock market to a record high.
The City is betting on another quarter point cut by March and a further reduction by the beginning of June, bringing rates down to 5.75 per cent. Gilts reacted favourably with the March long gilt future rising by half a point.
Yesterday's move brings rates to their lowest for a year and was welcomed by industry and commerce. But the absence of any endorsement from the Bank of England aroused widespread suspicions in the City that the Chancellor had dictated policy to a reluctant Eddie George, the Bank of England Governor.
While the FT-SE 100 index soared by 44.5 points to 3,748.7, sterling fell back on the foreign exchanges. The Bank of England's trade-weighted index against a basket of currencies fell from 83.2 to 83, near its all- time low, as the pound weakened against the dollar and mark on fears of a renewed leadership challenge to John Major.
Despite the pick-up in retail price inflation in December, Mr Clarke said he had made the decision "in the light of further evidence confirming inflationary pressures have continued to ease". The Chancellor pointed to stable earnings growth and a drop in factory gate inflation.
Mr Clarke said that the economic slowdown - with manufacturing output stalled in November and the economy growing below trend - had also led to the decision. The sharp falling away in important export markets, particularly in Europe, was also contributing to slower growth at home.
Further evidence of the seriousness of the European downturn came from Germany, where the IFO business climate index fell from 94.8 in November to 93.2 in December.
In France, meagre economic growth of 0.2 per cent in the third quarter of 1995 was confirmed.
Responding to the weakness of the economy, the French central bank cut the key intervention rate by 25 basis points to 4.20 per cent. The five- to-10 day lending rate, which acts as a ceiling, was cut from 5.85 to 5.60 per cent.
The Bank of England said the absence of any public comment on the rate cut marked a reversion to normal practice whereby the monthly monetary meeting remains confidential until the release of the minutes six weeks afterwards.
In a BBC interview, Mr Clarke said: "We refuse to give hints one way or the other."
However, the timing of the cut was generally regarded in the City as politically inspired, if justified by the state of the economy. "The economics left the door open but politics must have played a big part in the timing," said Paul Mortimer-Lee, of Paribas Capital Markets.
Bill Martin, chief economist at UBS, said: "I suspect the Governor might have wanted to wait a bit, but the Governor is no longer a constraint, the only effective constraint is the exchange rate. The Chancellor will press rates down to the limits of sterling's resilience."
Despite this assessment, it seems unlikely that the decision marks a re-run of last summer's open division between Mr Clarke and Mr George over interest rates. When the minutes are released, they are more likely to show Mr George was not pressing for a cut, but neither was he opposing one.
Roger Bootle, group chief economist at HSBC, said: "My guess is that he didn't oppose it outright, he is more likely to have acquiesced reluctantly."Reuse content