City expects Budget cut in base rates: Shares soar, mortgages fall after reduction to 6%

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BASE rates could fall to 5 per cent near the Budget on 16 March after the Chancellor yesterday cut rates to 6 per cent, their lowest since November 1977.

Major lenders quickly announced cuts in mortgage rates, although only half the 1 point reduction in base rates was passed on as they tried to balance the interests of savers and borrowers. The three largest lenders, Halifax, Abbey National and Nationwide, all opted to cut the basic loan rate from about 8.5 to 7.99 per cent, the lowest rate for 24 years.

The timing took markets by surprise but shares gained more than pounds 13bn as the FT-SE 100 index of leading UK stocks soared by 63.8 points to 2,835.7.

Although broadly welcomed, the cut failed to inspire confidence at Westminster, MPs privately questioning whether the Government was showing signs of panic over failure to achieve faster recovery. Michael Heseltine, President of the Board of Trade, did not know of the rate cut until he was questioned during a television interview.

The City saw the decision as a sign of growing government desperation over the elusive recovery. Government concern over business and consumer confidence deepened after last week's news that unemployment surged by 60,800 in December and the virtual certainty that the total out of work topped 3 million this month.

Norman Lamont and Robin Leigh-Pemberton, Governor of the Bank of England, decided to cut rates at a meeting on 13 January, deferring the decision only until economic statistics for December were released last week.

The cut was also backed last week by four of the 'seven wise men' appointed to advise the Treasury on economic policy. It lifted City hopes that the Chancellor would delay a rise in taxes to finance the public sector borrowing requirement explosion, forecast at pounds 44bn in the next fiscal year, at least until the second 1993 Budget, in December. That view was endorsed by the Institute of Fiscal Studies in its 'Green' Budget yesterday.

The Chancellor will be warned tomorrow not to raise taxes in his Budget when he meets the 1922 Committee of Tory backbenchers.

However, senior ministers said last night that Mr Lamont was preparing to raise pounds 2.5bn in value- added tax on domestic fuel bills. The move, to be presented as a 'green tax', is facing fierce opposition from Cabinet colleagues, led by the Prime Minister, who are against raising taxes.

After being forced to abandon widening VAT into areas such as newspapers, the Chancellor has told senior colleagues the imposition of VAT on fuel bills can be defended on environmental grounds: it would mean higher charges for households using the most fuel, ministerial sources said.

Mr Lamont's March Budget is also due to raise duty on petrol to pay for the abolition of car tax in the Autumn Statement at an annual cost of pounds 750m. That could add 9.4p to a gallon.

He said yesterday that the rate cut would not jeopardise the Treasury's 1 per cent to 4 per cent target for underlying inflation - the retail price index excluding mortgage interest payments. Despite a slight increase in last month's underlying rate, to 3.7 per cent, it was understood that the Treasury and the Bank of England were confident the target would not be threatened. But the City worried that underlying inflation will breach the official target ceiling late this year or early in 1994.

The Chancellor said that despite the easing in monetary policy last autumn and a recent upswing in business and consumer confidence 'a further 1 percentage point reduction is consistent with the necessary restraining influence on inflation'.

However, in the City the base rate reduction was seen as an attempt to justify a political decision on the basis of scant economic evidence. The Treasury said falling house prices, an 'appreciable' decline in pay settlements, and the lowest rise in factory gate prices since April 1969 indicated subdued inflationary pressures, despite an autumn surge in manufacturing industry's costs after sterling's devaluation.

After sterling's gains on Monday it was decided rates could be cut without jeopardising the pound. In the event, sterling fell 2.22 pfennigs to DM2.4270 and eased 0.9 points to 79.5 per cent of its 1985 value against a trade- weighted basket of currencies.

Gilt-edged stocks rose sharply with the best performance by inflation-proof index-linked stocks, which rose 1.5 points. But the base rate cut upset the gilt market, making more expensive today's auction of pounds 2.5bn of new stock.

Although recovery hopes were bolstered after the rates fall, several City economists critised the cut for taking risks with inflation.

Kevin Gardiner, of Warburg Securities, said: 'I don't find the Treasury explanation convincing, this brings forward the day when base rates will have to rise.' Mark Cliffe, of Nomura Securities, added: 'The Chancellor's justification appears spectacularly short-term in its thinking.'

----------------------------------------------------------------- Abbey National Mortgage ----------------------------------------------------------------- Interest only, monthly payments ( pounds ) Loan Old New Diff 30,000 159 150 9 50,000 301 283 18 70,000 432 409 23 120,000 759 722 37 150,000 962 914 48 200,000 1,299 1,235 64 -----------------------------------------------------------------