Fury after Bank stirs rate fever: Governor under fire from City

THE BANK of England and the Treasury are facing a barrage of criticism from the City for the way they triggered frenzied speculation on Friday about an imminent rise in interest rates.

Some economists believe that market reaction will force the Bank to raise base rates tomorrow, even if the Chancellor of the Exchequer and the Governor of the Bank agreed last Thursday that they should remain unchanged.

The Bank triggered speculation of an imminent rate increase by raising by three- quarters of a percentage point the interest rate at which it accepted tenders for Treasury bills. This spooked a market which had already been unnerved by a leaked survey from the Chartered Institute for Purchasing and Supply, which suggested strengthening upward pressure on factory gate prices.

'If no action is taken after this, the credibility of the Bank of England on money market operations will have collapsed,' said Roger Bootle of HSBC Greenwell. 'We are in a complete and total mess. This has done untold damage to the reputation of the market.'

'Base rate fever has given way to base rate chaos,' said Simon Briscoe of Warburg Securities. 'Confidence will now be undermined if they do not raise rates.'

The short sterling futures contract ended the week predicting base rates of more than 6 per cent by September, a three-quarter point increase from the current 5.25 per cent base rate. This market interest rate forecast has risen by more than half a percentage point in the last week alone.

The Treasury also came in for criticism. When City economists and dealers went to the Treasury to try to clarify the authorities' intentions, they found most of the relevant officials away on holiday.

The Bank will publish its quarterly inflation report on Tuesday, in which it will argue that it may have overestimated the gilts market's pessimism about inflation because of the way it calculates an implicit inflation forecast from conventional and index-linked gilt yields.

The inflation report will be accompanied by articles arguing that profitable investment opportunities may be being missed because companies are not taking account of low inflation when deciding on capital spending, while another will dispute the claim of some government ministers that the trend in the balance of payments is unimportant.

Nervousness about the authorities' handling of economic policy is also being fuelled by increasingly frequent City predictions that the Government will exploit a faster-than-forecast collapse in public sector borrowing to cut taxes ahead of the next election.

Bill Martin, chief economist at brokers UBS, argues in a paper published today that the Chancellor could choose to cut nearly six pence off the basic rate of income tax in the next two Budgets, thus reversing 80 per cent of the tax increases announced last year.

Mr Martin argues that private-sector incomes have been boosted by a decade of tax cutting, and that these incomes are increasingly being mobilised for spending.

'Propelled by this latent fiscal boost, the economy should deliver fast growth and a rapid reduction of the budget deficit - a development that will create demands for pre-election tax cuts, adding further fuel to an already inflationary boom,' he argues.

Similarly, David Miles, economist at Merrill Lynch, argues that the Chancellor could cut taxes by the equivalent of three pence off income tax next year without breaching current Treasury forecasts for Government borrowing.

Talk of tax cuts - encouraged by both the Prime Minister and the Chancellor of the Exchequer - is increasingly underlining City fears that the authorities will sacrifice hopes of a sustained, low inflation recovery for short-term political advantage.