Bank to dash rate cut hopes: Report will argue need for strong pound to keep inflation at bay

THE BANK of England will this week try to stamp out lingering market hopes of another fall in bank base rates from 6 per cent, warning that this could rekindle inflation.

The Bank, which took the initiative in proposing the last interest rate cut in January, much to the annoyance of the Treasury, will be more cautious in its forthcoming inflation report, released tomorrow.

The Bank's opposition to a rate cut is shared by the Treasury and the Chancellor, because of the growing official belief that a strong pound is needed as a bulwark against rekindled inflation pressures as the economic recovery gets under way.

The Bank will argue that the 5 per cent rise in sterling since the last inflation report in February has helped to moderate import price rises and hence inflation pressures. But at that time, the Bank warned about the risks that underlying inflation could breach the upper end of the Government's 1-4 per cent target range.

The Bank will point out that there is still a limited margin of error given that the Treasury's preferred measure of inflation, which excludes mortgage interest rates, is now 3.5 per cent and is forecast to ease only slightly when the April figures are released on Friday.

Despite the better-than-expected inflation figures since the beginning of the year, the strength of sterling, and weak pay pressures, the Bank believes interest rates must stay up to bolster the pound. Its opposition to lower rates is based on the notion that the pound must remain firm to contain any future inflation pressures as the recovery gains ground.

There is nevertheless lingering concern that Downing Street could press for another cut if the Conservatives' political crisis deepens, or if the recovery suffers a setback. Figures out this week for retail sales volume and unemployment are likely to show that the economy has lost some of its dynamism, City economists predict.

After strong gains in January and February, factory output for March may show a rise of only 0.2 per cent. Industrial production could decline because of weak North Sea oil output.

High street sales are meanwhile predicted to rise by 0.3 per cent when April figures come out on Wednesday.

Pressure for lower rates could also re-emerge if the pound resumes its upward trend. Last week, however, sterling fell by 2 pfennigs to DM2.4677 and by 3.6 cents to dollars 1.5382 as fresh misgivings over John Major's political survival emerged. But the powerful combination of sustained recovery and a further slide in German rates may restore sterling's fortunes, giving the Government theoretical room to cut rates again with a low inflation risk.

January's fall in rates was pressed on Norman Lamont and a reluctant Treasury by 10 Downing Street, with the backing of Eddie George, the incoming Governor of the Bank. This time, the Bank is making it plain that the trough appears to have been reached.

(Photograph omitted)