Prospect of higher base rates sends sterling soaring

The pound rose and shares fell yesterday after data showing the economy remained buoyant increased the threat of higher interest rates later in the year. Analysts took comfort from better-than-forecast personal savings figures and an unexpectedly resilient export sector, but they said an upward revision of second-quarter GDP figures meant the upward trend in base rates would soon resume.

The economy grew by 3.5 per cent in the second quarter, new figures from the Office of National Statistics showed yesterday, a revision from the previous estimate of 3.4 per cent and well above the 2.25 to 2.5 per cent analysts believe is sustainable without stoking inflation.

"The upward revision to these figures confirms that activity in the second quarter was very strong," HSBC economist Dharshini David said. "Bearing in mind the strength of other recent indicators, we still see base rates as not having reached their peak yet."

Interest rates have increased on four occasions since the election but expectations in the money markets are for a further quarter-point rise to 7.25 per cent. Many economists believe rates will rise to 8 per cent before peaking.

The currency markets saw the data as a sign of tighter monetary policy to come and pushed the pound 2 pfennigs higher to DM2.89 in expectation of a better return on sterling. The prospect of higher rates knocked shares, however, with the FTSE 100 index of leading shares closing 48.2 points lower at 5027.5.

There were further concerns the full impact of building society windfall payments had not yet shown through in the official statistics. Some spending - on holidays and R registrations cars - might not show up until later in the year.

However, economists took heart from a rise in the personal savings ratio from 10.4 per cent of income to 11.7 per cent. During the late 1980s boom the same ratio was only half as much.

Another surprise was the relatively insignificant impact on exporting companies of the high pound. Although Britain's trade surplus declined in the second quarter from pounds 1.35bn to pounds 888m, the three month period was the third in a row that trade balance had been in the black.