MPC's Barker hints that plunging stock markets may stall rate hike

£45bn wiped off value of FTSE 100 while raft of companies issue warnings on profits

Plunging share prices may save homeowners and businesses from a hike in interest rates next month, according to a strong hint from a member of the Monetary Policy Committee yesterday.

The London stock market plunged more than 4 per cent, wiping more than £45bn off share values and leaving the market 39 per cent off its peak at the end of 1999.

Speaking as the markets were tumbling, Kate Barker said the falls had "clouded" the outlook for the economy.

"The second half [of the year], following the events of the past few weeks, is more clouded than one would have hoped a month or two ago because of the falls in equity prices and what that's going to do to US growth," she said.

Her comments came as the Financial Services Authority warned it was keeping the insurance industry under close watch in the wake of the share price falls. The markets reacted badly to the FSA's statement as insurance giants were among the worst casualties with blue-chip names such as Prudential and Legal & General falling about 7 per cent.

John Tiner, the FSA's managing director, told MPs yesterday: "These are nervous markets, and we continue to monitor closely the impact of market movements on the life insurance industry as a whole and on individual firms."

Fears have been growing that plunging stock markets would put some insurers into insolvency as their asset base would become too small.

Stephen Lewis, the chief economist at Monument Securities, who has flagged up the danger of an insurance crisis, said the FTSE 100 would have to approach 3,500 points before the alarm bells went off.

"As long as it stays above the level the situation won't be comfortable but it will be tolerable," he said. "Below that and they would be forced to take defensive action and one would see a fast flow of funds out of equities and into gilts."

There are mounting fears that falling share prices will undermine consumer confidence at a time when the economy is emerging from stagnation.

"It is very easy for the virtuous circle to become a vicious cycle," said Jeremy Batstone, the head of research at NatWest Stockbrokers. "If a bubble were created in the housing market and required some sort of [rate rise] then, coupled with a sharp deterioration in equity markets, that could result in lower consumer spending and the economy could be stopped in its track."

However Ms Barker gave a broad hint the MPC would not hike rates simply to burst a bubble in the housing market.

"It is absolutely clear that we are not targeting house prices," she told Reuters news agency. "What we are doing is looking at the effect of stronger house prices on people's spending ... and balancing that against the potential negative effect from the fact that people will have noticed their stock market holdings have fallen."

She echoed other MPC members' views that the growth in house prices – now running at an annual rate of 20 per cent – was "unsustainable". But she went on: "People then tend to take it as though we are talking about the level of prices being unsustainable and that is by no means the case.

"If you look across at all the indicators ... it isn't clear there is a bubble."

She also played down the significance of the first estimate of GDP growth for the second quarter of the year, due to be published just days before the MPC's meeting on 31 July and 1 August. Some analysts expect this could show growth as high as 1 per cent in the wake of a manufacturing recovery in May.

"The pattern of growth is slightly puzzling ... we are trying to look through the whole first half because the data have been unusually bumpy. We shall be trying to get a feel for where the trend of growth is," Ms Barker said.