Bank Governor rules out cut in interest rates

THE GOVERNOR of the Bank of England last night in effect ruled out a cut in interest rates at the time of the Budget and argued that a stronger pound would 'greatly assist' the Government in keeping to its inflation target.

The Bundesbank is expected to cut German rates either this Thursday or a fortnight later, but the Government has decided not to use this to justify an early cut in British base rates. This implies a narrowing in the gap between the key German discount rate - currently 8 per cent - and the 6 per cent British base rate.

Hopes of an early cut in German rates pushed the pound sharply higher and saw the stock market climb to a record closing high. The FT-SE index of 100 leading London shares ended 14.6 points up on the day at 2,882.6.

The pound rose almost four pfennigs against the mark to close at DM2.3710. Against a basket of currencies it rose by 1.1 points to end the day at 77.1 per cent of its 1985 value.

The Bank Governor, Robin Leigh-Pemberton, said in a lecture in Bristol last night that the pound was likely to rise if Germany and other European countries cut their rates.

'In such circumstances there would be no question of the UK seeking to hold the exchange rate down to maintain a competitive advantage. The appreciation of the exchange rate which would result from easier policies elsewhere would greatly assist the achievement of the Government's target for reducing inflation,' he said.

Mr Leigh-Pemberton added that monetary policy might need to be tightened if the weak pound threatened the inflation target.

Norman Lamont, the Chancellor, told his fellow finance ministers from the Group of Seven leading industrial countries over the weekend that he did not plan to cut rates for several months.

The case for holding fire on British rates was strengthened by an unexpectedly sharp leap in the amount of cash circulating in the economy last month. The narrow money supply measure, M0 - largely notes and coins - rose by 4.8 per cent in the year to February, the second successive month in which it has exceeded the Chancellor's 4 per cent target ceiling.

The Treasury believes that cuts in interest rates have added as much as 2 per cent to M0's rise over the past 12 months. Lower rates have reduced the penalty for keeping wealth as cash rather than in an interest-bearing account.

John Shepperd, of Warburg Securities, said that despite the distortion from lower interest rates, M0 did point to 'a continued firm trend for consumer spending'.

The broad measure of money supply, M4 - which includes cash and bank and building society accounts - rose by 3.2 per cent in the year to January, well below the 4 per cent target floor.

The Bank of England's monetary statistics also showed the first clear evidence that high street banks are restructuring their investments to buy more gilt-edged government bonds.

Clearing bank holdings of gilts rose by a dramatic pounds 2.5bn in January to pounds 7.3bn. This shift increases pressure on the Government to abandon the 'full-funding' rule, which would allow debt sold to banks and building societies to count towards the financing of the ballooning public sector borrowing requirement.

But reports that the PSBR will undershoot the Treasury's pounds 37bn Autumn Statement forecast this year helped to boost the prices of long-dated gilts, with the strong pound also underpinning the rise. The 9 per cent stock due in 2008 rose by 14 32 to close at 10630 32 , yielding 8.2 per cent. The Bank exploited the market's strength by issuing pounds 1bn of new bonds.

The Bundesbank yesterday moved to nudge down German money market interest rates, by boosting liquidity in the market following a cut in German banks' minimum reserve requirements.

Alison Cottrell, of Midland Global Markets, said this might herald a cut in the German 'repo' rate this week from 8.5 to around 8.35 per cent. She believes a cut in the key discount rate will have to wait until 18 March.

Analysts said the chances of a repo rate cut this week had been boosted by the Bundesbank's unusual reluctance to criticise the latest German inflation figures, which showed consumer prices rising 4.2 per cent in the year to February.

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