George comment on lower rates lifts gilts

Eddie George, Governor of the Bank of England, lifted spirits in the gilts market by saying that an era of lower inflation should mean lower interest rates, writes Diane Coyle.

Mr George, speaking at a conference hosted by the Building Societies' Association, said greater price stability should make for less financial uncertainty. This would reduce the uncertainty premium demanded by investors in bonds and allow real interest rates to fall.

Some traders in the gilts market decided to interpret this as a softening of the Bank's position on base rates.

Minutes of his regular meetings with the Chancellor of the Exchequer show that Mr George recommended a rise in base rates in May, June and early July, but he is thought to have subsequently advised holding rates unchanged.

After his remarks yesterday short sterling futures jumped, pointing to interest rates of 6.55 per cent by the end of the year. Long gilts also rallied, closing up half a point. Stuart Thomson at Nikko Europe said the comments suggested a change of emphasis. However, other analysts said the speech did not refer to specific UK conditions. Mr George made the interest rate remarks in a section of the speech about economic policy in the leading industrial nations.

He also said that low inflation meant falls in house prices would become more common than they have been in the past. Demand for housing purely as an investment would shrink, making house prices rise more slowly over time.

DIANE COYLE

Economics Correspondent