View from City Road: Bundesbank opens door for the Chancellor

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The Independent Online
Hans Tietmeyer has handed the Chancellor a perfect excuse to cut base rates - if one were needed. But the fact that the Bundesbank council decided to act immediately, wrongfooting the market on the question of timing, presents Kenneth Clarke with a dilemma.

Hopes of a cut in base rates lifted sharply yesterday, with predictions of a two-stage fall to 5 per cent around the end of the year.

Everything depends on the strength of the exchange rate which, if yesterday's performance is any guide, should be underpinned by expectations of further falls in German rates. The markets are now looking for another cut in December, which will take the gloss off the mark.

The Chancellor thus faces the pleasant prospect of cutting base rates into a rising pound, which helps to explain why markets have shed their recent caution.

Yet Mr Clarke might be a happier man if he could deliver his Budget in two weeks' time, when the clamour for a cut in base rates is likely to reach a peak. The Budget, however, is almost six weeks away and if Mr Clarke frustrates market expectations simply to tie in a rate cut he may risk damaging favourable sentiment.

There is always a window of opportunity for actions like rate cuts. If Mr Clarke misses this one he could be accused of political manipulation, holding back to offset the bleak economic message of Budget tax increases.

Political manipulation of interest rates is something Mr Clarke has promised not to engage in. More significantly, it is something the former Chancellor, Norman Lamont, has accused the Government of doing in the past.

There is also the risk that another bad inflation figure could spring up and deliver a nasty surprise. A lot can change in market perceptions in six weeks.

But, when all is said and done, the long-term trend in interest rates here and on the Continent is downwards. A stronger pound and lower European rates provide, at some point this autumn, the opportunity for lower British interest rates. Further German cuts, a weaker mark and the first blow to consumer spending from 1994 tax increases will provide fresh reasons to cut away again.