European interest rate rises hit British gilts and shares: Swedish and Italian changes prompt fears of Bank of England following suit

GILTS and share prices took a hammering yesterday as rises in Italian and Swedish interest rates fuelled fears that the Bank of England might soon follow suit.

The Swedish central bank said it was raising the ceiling of its target range for market interest rates from 7.5 to 8 per cent 'to counteract, at an early stage, a tendency towards higher inflation'. This is precisely the sort of move that Eddie George, the Governor of the Bank of England, has said may be needed in Britain before long.

Alison Cottrell, international economist at HSBC Greenwell, said the Swedish move was 'pre- emptive in the extreme'. But analysts were struck by the similarity between the inflationary danger signals identified by the Bank of Sweden and those to which the Bank of England has drawn attention - rising capacity utilisation, a weak currency, rising commodity prices and strengthening recovery in the world economy.

The Bank of Italy said it was raising its official discount rate from 7 to 7.5 per cent in order to defend the lira, which has recently been under strong pressure.

But the markets were so unnerved by the move that the lira promptly fell to a record low of 1,015 per German mark, while Italian bond futures plummeted. One dealer in Milan described the Italian rate rise as suicidal.

Kit Juckes, of Warburg Securities, said the central banks were raising rates 'not because they had to but because they were able to'. He said they were urging responsible tax and public spending policies on their governments.

The two moves, together with poor US factory gate inflation figures, sent European bond markets lower. Bund futures dropped sharply, while the yield on 10-year German government bonds was pushed up from 7.01 to 7.11 per cent. Analysts said an early cut in the Bundesbank's discount rate appeared much less likely.

The FT-SE index of 100 leading London shares ended the day 28.8 points lower at 3,138.2. Gilts fell sharply, with the benchmark 63 4 per cent stock due 2004 shedding almost pounds 2 to yield more than 8.7 per cent. The forecast of December base rates in the futures market rose from 6.57 to 6.77 per cent.

Gerard Lyons, economist at DKB International, said the only way the Swedish and Italian rises were likely to prompt rises in British rates was if they pushed the pound significantly lower. Receding hopes of a German cut pushed the mark higher in late trading, although it ended in London with the pound half a pfennig higher.

The mark rose sharply against the dollar in New York as factory gate inflation figures shortened the odds against another rise in US rates after next week's meeting of the Federal Open Market Committee. Producer prices rose 0.5 per cent last month, while retail sales dropped 0.1 per cent.

Market Report, page 24