Leading Article: Cut interest and save the recovery

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ON THE face of it, the continuing surge in the stock market and the ringing tills on Britain's high streets are both arguments against any further cut in interest rates. British consumers have come out of hibernation, even if more of their spending has been weighted towards post-Christmas bargain- hunting than retailers would like.

The sage voices will argue that cheaper money is unnecessary, and maybe even irresponsible. If the recovery begins to flag later in the year, the Chancellor can always react by cutting interest rates. After all, one of the advantages of using interest rates to influence the economy is precisely that they are more flexible than changes in taxes or public spending. The Chancellor can afford to react to events, rather than anticipate them.

This cautious case is plausible but misguided. Interest rates are not as flexible as they seem. Nearly half of the payments on all the

8 million outstanding mortgages are in fact on annual review, which means that they are changed only once a year. And many of them, as we report today, are changed between January and March. So the Chancellor needs to cut bank base rates quickly if he is to offset fully the depressive effects of the sharp cut in real incomes administered by the two 1993 budgets.

The list of tax increases that come into effect in April is awesome - frozen personal allowances, a cut in mortgage tax relief, a one percentage point rise in employees' National Insurance. All in all, tax increases and spending cuts worth more than 2 per cent of national income will hit the economy. This is thoroughly justified as an attack on the budget deficit, but the quid pro quo has to be a substantial offset through interest rate cuts to keep the recovery going.

Although interest rates have come down sharply since their 15 per cent peak, they are still relatively high if compared with either inflation or the interest rates in similarly indebted countries. Nor can it any longer be seriously maintained that there is an imminent threat of inflation. Earnings are still slowing down, and the underlying rate of inflation is still subsiding, even though it is at a near 30- year low.

The inflation outlook is unlikely to worsen while the economy is still growing too slowly to use up the reserves of spare capacity and sustain the fall in unemployment. Moreover, sterling is now rising as money floods in to take advantage of the recovery. This will reduce import prices and further cut inflationary pressures. It will also lessen the advantage which British exporters have reaped from the devaluation after the pound's exit from the exchange rate mechanism, and damp down one of the few positive forces that have aided an otherwise feeble upturn.

Today's economic risks are not that inflation will take off, but that the recovery will stall in the face of the spring tax increases. The Chancellor would be wise to cut bank base rates to 4 per cent while he can still have a full effect on mortgage payments.