Rates rise but Clarke rules out tax cuts

KENNETH CLARKE, the Chancellor of the Exchequer, took Westminster and the City by surprise yesterday when he put the interest rate up by half a percentage point - the first rise since 1989. He also ruled out any tax cuts in November's Budget.

Pushing the rate up to 5.75 per cent is meant to prevent economic recovery, reflected by the fastest growth in output for six years, being derailed by inflation. Mr Clarke added to the troubles of Tory party managers a month before the annual conference by dismissing talk of tax cuts as 'cloud-cuckoo land'.

As the Tory chairman, Jeremy Hanley, published a conference agenda bristling with resolutions protesting at tax rises and praising the previous 5.25 level of interest rates, Mr Clarke said the rate rise 'underlines our commitment to economic recovery that will last'. He added: 'It will last because we are taking no risks with inflation, therefore avoiding a repeat of the historical experience of this country, when periods of strong growth have always been brought to an end by the recurrence of the old British inflationary disease.'

Millions of mortgage-holders and businesses now face higher interest payments. The Abbey National and Nationwide both raised their mortgage rates immediately, but some other lenders said the housing market was too fragile to increase borrowing costs.

Mr Hanley, chairing his first set- piece news conference since becoming chairman in July, did little to remove his reputation for shooting from the hip when he appeared to second-guess the Treasury and implied yesterday's interest rate hike would be the last. He praised the rate rise as a 'courageous act by a cautious Chancellor', but added: 'What we have to make sure is that that interest rate rise is it.' Earlier, Mr Clarke had studiously avoided committing himself either way on future interest rate changes.

City economists were left pondering when the next rise would come, with some expecting one this year and others expecting nothing until early 1995. Most said the rise - the first in five years apart from the hastily reversed attempt to prop up the pound on 'Black Wednesday' in 1992 - could hit consumer confidence, but was unlikely to have much impact on the pace of economic growth.

The reaction of most Tory MPs to the rate rise - decided last Friday - was muted, with apprehension about the impact of higher mortgages tinged with admiration for Mr Clarke's uncompromising refusal to make any concessions to short-term popularity.

The underlying rate of inflation - which excludes mortgage interest payments - stands at 2.2 per cent, a 27- year low. But the Chancellor fears the economy is growing too quickly for underlying inflation to hit his 1-to-2.5 per cent target for the end of the parliament.

Mr Clarke took the decision to raise rates on Friday, agreeing with the advice of the Governor of the Bank of England. The move sent the pound up sharply on the foreign exchanges.

In a deliberate shift away from ritual denunciation, Tony Blair, the Labour leader, said: 'If the Government is being advised that inflation is back in the system they have to act upon it.' But he added that the rate rise demonstrated the 'fundamental failure' of government policy and was a 'huge blow to businesses and homeowners'.