Interest rates ready to fall

INTEREST rates have reached their peak and are likely to start falling now, thanks to an unofficial relaxation of inflationary targets by the Government, according to Roger Bootle, a leading City economist.

His forecast marks a sea-change in the sentiment sweeping through the markets, which have until now been anticipating higher interest rates for the rest of this year. Although many economists still believe there are upward pressures on base rates, opinion is swinging round to the view that rates may, at worst, remain at their current level of 6.25 per cent.

The change of attitude will deeply colour the markets' reaction to Wednesday's monthly meeting between Kenneth Clarke, the Chancellor, and Eddie George, governor of the Bank of England, when interest rates are expected to be held stable. At last month's meeting, Mr Clarke was harshly criticised for blocking a rate rise favoured by the Bank of England. This time, however, the City will support his view that interest rates do not need to alter.

Mr Bootle, chief economist at Midland Bank, believes that the next interest rate change will be downwards because the economy is now clearly weakening. "The overwhelming evidence of economic indicators in this country and abroad is that activity is slowing," he said.

As part of expansionary policies to counteract a slowdown, Mr Bootle forecasts tax cuts of pounds 4bn to be announced in November.

The other key factor improving the interest rate outlook is the more relaxed attitude to inflationary targets by Mr Clarke. The Government had set an upper limit for inflation of 2.5 per cent by next year. In a recent interview, however, Mr Clarke said that inflation at 3 per cent would be "not much short of a triumph when you look at previous British recoveries".

Mr Bootle believes that interest rates may start falling as early as this autumn and will be back down to 6 per cent or less by the next general election. That would mean a reduction in average mortgage rates of about 0.75 per cent from current levels.

The financial markets are beginning to share Mr Bootle's view. The short sterling futures contract is indicating that investors believe interest rates will not change over the next few months. Over the longer term, markets are indicating that they expect no change or a slight fall. This is a reversal from only a few months ago, when they were indicating rates as high as 9 per cent by the end of this year.

Mr Bootle's view of weakening economic activity in industrialised countries was strongly supported on Friday by much worse-than-expected US employment figures for May. US stocks and bond yields fell sharply on fears of a sharp economic slowdown.

But many City economists believe the evidence in the UK is still confusing. "The economic data is conflicting," said George Magnus, UK economist at SG Warburg. "There are some bad indicators but plenty of positive stuff, too. Earnings are rising, taxes are likely to fall, and exports are good, so the economic picture in the second half of this year ought to improve."