Markets crumble under twin attack: US production figures reinforce fears of early rate rise Gilts in turmoil after jump in borrowing requirement

FINANCIAL markets plunged after a sequence of bad news yesterday. The announcement of higher- than-expected government borrowing in Britain was followed by figures suggesting the US economy was still growing too quickly.

The gilts market turmoil meant the yield on 10-year government bonds rose from the previous close of 8.76 per cent to 8.96 per cent.

The Bank of Englandsaid an auction of 10- to 12-year gilts would go ahead as planned on 28 September, and it would announce details of the terms on Tuesday. The cost of government borrowing is likely to be significantly higher than the 8.29 per cent at the last auction in July.

The Government's borrowing requirement was pounds 3.2bn in August, up from pounds 1.1bn in July. Excluding privatisation proceeds of pounds 1.3bn, mainly from the auction of debt in privatised utilities, the shortfall was pounds 4.5bn.

The Treasury said it was too early to conclude that the official forecast of a pounds 36bn public sector borrowing requirement in 1994/95 was under threat.

Analysts said the disappointment in August was due to an increase in government expenditure, but most agreed one month's figure could not be taken as the start of an unfavourable trend.

Central government departmental spending, at pounds 20.3bn, was 9 per cent higher last month than in August 1993. However, Don Smith, UK economist at Midland Global Markets, said: 'Departmental spending remains very low this year compared with previous years.'

Total cash receipts of pounds 17.2bn in August were 10 per cent higher than a year earlier. In the first five months of the financial year they totalled pounds 87.1bn, 5.6 per cent higher than at the same stage the previous year. Some analysts said this was surprisingly low, given the pace of economic growth.

The PSBR for the financial year to August was pounds 15.5bn compared with pounds 18.1bn at the same stage of the previous year.

The disappointing PSBR statistics launched the fall in gilts prices. Adrian Cooper, an economist at James Capel, said: 'The gilts market had been getting excited by the prospect of the PSBR undershooting the Treasury's target. The figure takes the edge off that excitement.'

Buoyant figures on capacity utilisation and industrial production in the US subsequently hit markets on both sides of the Atlantic. The rate of usage of capacity was 84.7 per cent in August, the highest since April 1989. Economists said a figure above 84 was evidence of inflationary pressure.

Industrial production increased 0.7 per cent in August, and the Federal Reserve Board also revised upwards its estimates of output during the previous three months.

Analysts also blamed tensions over Haiti and the faltering US- Japan trade talks for the nervousness. Chris Iggo, an economist at Chase Manhattan bank, said: 'Unless there are better economic statistics, the markets here will not settle down until the Fed acts.'

Raphael Marrone, an analyst at Deutsche Bank Securities in New York, said: 'The figures put the Fed on notice that it will have to tighten rates sooner rather than later.'

The Federal Open Market Committee, responsible for setting monetary policy, meets on 27 September and in mid-November. Analysts thought a November increase in interest rates remained the most likely decision, but said there was now a bigger risk of an earlier rise.

The Dow Jones Industrial Index had fallen 20 points to 3,933 by the close, while the benchmark US Treasury bond had lost nearly two points to yield 7.78 per cent. The FT-SE 100 index closed 47.6 points lower at 3,065.1, more than reversing the previous day's gains.