Markets soar on rate hopes: Disappointing retail sales and better inflation news sends shares and bonds rocketing

SHARE and bond prices soared yesterday as speculation about an early cut in interest rates was fed by disappointing retail sales in December, contradicting earlier hopes of a high street Christmas boom, and better- than-expected inflation figures.

The FT-SE 100 index of top company shares closed 38.1 points up at a record 3,475.1 after rising 47.5 to a new intra-day high of 3,484.5 at lunchtime.

But the most spectacular gain, up 135.5 to a record 4,148.8, was in the FT Mid 250 index of shares in second-line companies, which are more geared to the UK recovery than large multinationals in the FT-SE 100. The gains were worth pounds 6bn to both indices.

Equity volume jumped to 1.32 billion shares, the highest level since sterling left the Exchange Rate Mechanism in September 1992. The number of deals rose sharply to 49,145, compared with 36,984 on Tuesday.

Government bond prices also rose sharply on interest-rate speculation. The longest-dated bond, Treasury 8.75 per cent 2017, rose by almost pounds 2 to yield 6.41 per cent.

Retail sales volume fell by 0.2 per cent between November and December, after adjusting for the large increase in trade that is normal for the run-up to Christmas, according to the Central Statistical Office. City economists had expected a 0.5 per cent increase, following anecdotal evidence from stores groups reporting bumper Christmas trade.

'Quite simply, we do not believe the figures give an accurate representation of retail sales over the Christmas period', said Nick Parsons, of Canadian Imperial Bank of Commerce. 'The figures contradict every known piece of evidence on the British economy', he said.

But Ian Shepherdson, of Midland Bank, said the figures were in line with Tuesday's survey of retailers by the Confederation of British Industry. 'This will create enormous political pressure for lower interest rates', he said.

Sales volume between October and December was 0.7 per cent up on the previous three months, with department store chains significantly outperforming single outlets and local chains. The value of sales in each week of December averaged pounds 3.8bn, giving sales of pounds 148bn for 1993 as a whole.

The City was less surprised by the jump in the inflation rate from 1.4 to 1.9 per cent in December, as Budget increases in excise duties on tobacco and petrol took effect and as cuts in mortgage interest rates a year ago fell out of the annual comparison of prices.

Prices rose by 0.2 per cent between November and December. This was more than accounted for by Budget increases in excise duties, although only three-quarters of the increases were passed on to consumers.

The Government's underlying measure of inflation, excluding mortgage interest payments, rose from 2.5 to 2.7 per cent. The supermarket price war saw the rate of inflation for non-seasonal food fall to 1.1 per cent, the lowest since 1967. The inflation rate for household goods was also the lowest since 1967.

Hopes of another rate cut are likely to be boosted further today by the latest quarterly survey of 8,000 companies by the British Chambers of Commerce, which warns of a 'flattening recovery'.

Demand for shares by both large institutions and private investors has been stimulated by fears of falling income on holdings of cash as interest rates seem set to fall further.

The average yield on shares at 3.5 per cent compares with a 4 per cent yield currently available on a pounds 5,000 building society deposit.

Robert Buckland, strategist with NatWest Securities, expects base rates to fall by half a point to 4.5 per cent, probably by March, and sees further scope for share gains. 'In the past week shares have returned more than money left on deposit for a whole year. It takes a brave person to stay in cash and out of equities.'

The Commons Treasury Committee meanwhile backed the Chancellor's decision to tighten fiscal policy sharply in the November Budget but a significant minority warned that the April tax increases could put the recovery at risk.

The committee nevertheless criticised Kenneth Clarke for being too categoric in saying his Budget completed the task of sorting out the public finances. But it endorsed the Treasury view that annual average growth of 3 per cent over the medium term was a reasonable projection. And it called the short-term outlook for inflation good.

In a report on the Budget published yesterday, the Treasury and Civil Service Select Committee said a majority of its members thought that despite the scale of fiscal tightening, the complete long-run impact of interest-rate cuts on the economy should not be underestimated.

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