City bets that Chancellor will cut rates: High street recovery sets record in September but export orders fall after three quarters of improvement

SPECULATION that Kenneth Clarke will cut interest rates in his Budget next month - or even before - intensified yesterday. German interest rates edged lower and official figures and surveys in Britain pointed to a continued recovery in high street spending combined with a fall in export orders.

The stock market rose to another record high, while the gilts and money markets signalled that a base rate cut was increasingly likely. The FT-SE 100 share index closed 26.7 points higher at 3,156.3, while the three-month interbank lending rate - which tracks base rate expectations - fell one-eighth of a percentage point to 511 16 per cent.

High street spending volume rose by 0.5 per cent in September to its highest level on record, according to the Central Statistical Office. Britons spent an average of pounds 2.78bn a week in the shops during the month. The increase since August was larger than the City expected.

But the latest quarterly survey of 8,000 businesses by the British Chambers of Commerce found a sharp fall in export demand following three quarters of improvement. The fall was particularly steep among manufacturers. Domestic demand improved slightly for the fourth successive quarter.

The BCC said weakening export demand could threaten what was already only a slow and hesitant recovery. 'It is competitive exporting that holds the key to whether we stay on course for sustainable growth,' Christopher Stewart- Smith, BCC president, said.

The rise in high street spending suggests that recovery in domestic demand remains intact, which may persuade Mr Clarke to raise taxes again next month. But the weakness of exports may convince him to cut base rates at the same time to keep the pound competitive.

Pressure for a rate cut will mount if the continuing slow fall in rates elsewhere in Europe pushes the pound higher and makes British goods less attractive in already recession-hit European markets. The pound rose 0.2 points yesterday against a basket of currencies to 79.9 per cent of its 1985 value.

European rate reductions continued yesterday with a three-basis- point cut in the German securities repurchase pact to 6.67 per cent. The cut in the repo, the main influence on German market rates, suggests rate reductions have resumed, albeit at a crawl.

But few in the market believe the Bundesbank action signals a cut in the key discount rate, now 6.25 per cent, before next month. Only a handful of analysts think that today's Bundesbank council will approve a cut in the discount rate.

Growth in German money supply M3 slowed 0.2 points to an annualised 7 per cent in September, slightly above forecasts.

Spain, Denmark and Portugal have all shaved their interest rates in recent days but France has avoided acting before Germany does. Analysts worry that unless there is a more pronounced fall in European rates soon the recent upswing in European share prices could suffer a sharp setback.

British retail sales in the third quarter of the year were 1 per cent up on the previous three months, double the rate of growth between the first and second quarters. Sales growth in the third quarter was most marked for household goods, with a 2 per cent increase on the previous three months.

The figures suggested that department store chains are doing better than single shops. This may be because they are in a stronger position to discount their prices aggressively. Ian Shepherdson, economist at Midland Global Markets, said this was a good omen for next month's inflation data.

Hugh Clark, trading policy director of the British Retail Consortium, said sales so far in October remained robust. He urged the Chancellor not to increase or extend VAT on retail goods but, if it was unavoidable, to do so only after the retailers' busy Christmas season.

The cheering sales figures were in contrast to subdued bank lending. Total lending by the big British banks fell by about pounds 100m in September following increases of pounds 1.1bn on average in recent months.

Lord Inchyra, British Bankers Association director-general, said: 'September's small fall emphasises the weakness in the recovery of lending which the banks had been experiencing over the last few months. The only strong demand continues to be for mortgages, while the company sector is still intent on repaying bank debt.'

The Building Societies Association reported a 5 per cent increase in net mortgage commitments to pounds 2.6bn in September. But it warned that lending was unlikely to pick up significantly before year-end - 'in line with the frail nature of the recovery in the housing market', Adrian Coles, its director-general, said.