View from City Road: Light hand on the interest rate tiller

Recovery in the productive sector of the UK economy appears to be strengthening slightly, to judge by the latest manufacturing output figures for February.

But you would not think so from the behaviour of the FT-SE 100 index, which lost all of an earlier 12- point gain to close 2.5 down at 3,129.0.

In the current Alice in Wonderland world, good news in the real economy is bad news for financial markets. Just as in the US any sign that activity is picking up on a sustained basis raises fears that inflation will rise, interest rates will not be cut or could go higher.

Since the bond market tail is still firmly wagging the equity market dog, the more the steam goes out of share prices the better is the news from the real world. In the US the remarkable strength of the economy since the autumn - growth of 7.5 per cent in the fourth quarter of last year and maybe 3.5 per cent in the first quarter of 1994 - has not been accompanied by any signs of resurgent inflation.

This may not continue to be the case and the Federal Reserve will clearly have to move short-term rates higher to maintain reasonable real rates of interest as and when inflation picks up.

The UK looks to be some way away from a similar position. After all, a 0.6 per cent rise in February manufacturing production, although ahead of City expectations, means that in the latest three months factories are producing just 2 per cent more than a year before, much the same rate of increase as in recent months and only slightly faster than in the late summer and autumn.

If this suggests that manufacturing is jogging slowly along, then it is supported by the recent round of 1993 company results. Few company chairmen, other than the thoroughly bombed-out, have claimed to be receiving much help at all from their market places.

A subdued output performance from consumer industries - up only 0.6 per cent on the previous three months - looks a poor preparation for this month's onslaught from higher VAT and personal taxes.

Most of the impetus is coming from investment industries - up by 1.8 per cent on the previous three months - which may be either home demand or more likely overseas purchases.

Taken together, it suggests a light hand on the UK interest rate tiller. But it may take some really bad news to underline this and boost the London stock market.