Cash surplus could push up rates

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FEARS that Kenneth Clarke could be forced to raise interest rates before the end of this year were stoked up yesterday by figures that showed a rapid growth in manufacturing and the biggest rise in the amount of cash in circulation in the economy for four years.

The narrow money supply measure, M0 - cash plus the money commercial banks keep at the Bank of England - rose by 0.2 per cent last month, giving an annual rate of increase of 7.1 per cent in the year to May, the Bank said. This is well above the Government's 0-4 per cent 'monitoring range'.

M0 is seen as a guide to the strength of high-street spending and future inflation. The Treasury and the Bank say M0 growth above 4 per cent need not be inflationary because low interest rates mean people lose less if savings are kept as cash. But John Marsland of the City firm UBS said M0 growth had exceeded its target range for the first time last month after adjustment for the interest rate effect.

The latest purchasing managers' index from the Chartered Institute of Purchasing and Supply pointed to strong growth in manufacturing industry last month, with some companies having difficulty meeting demand. It showed that manufacturers found it easier to raise their prices for the sixth month running - bad news for inflation.

Fears that interest rates in Germany might also start to rise by the end of the year hit European government bond prices. The slide coincided with a fresh surge in commodity prices led by a remarkable recovery in the price of coffee.

In May alone, coffee prices have risen by 50 per cent and they have doubled since the start of the year. Cocoa prices also rose.

Indications of further sharp gains in commodity prices came after a basket of commodity prices was pulled up sharply by big rises in prices for grain and soya due to dry weather in the US Midwest.

Analysts explained the decline in bonds by citing worries over German rates, but Julian Jessop of Midland Global Markets said: 'the simpler explanation is that investors think that prices are going lower next week.'

But worries about US inflation abated yesterday, after a sharp fall in sales of new homes and weakening consumer optimism.

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