Danger exaggerated, says George

Eddie George, Governor of the Bank of England, said yesterday that financial markets were exaggerating the inflationary dangers facing the economy and the extent of interest rate rises that might be needed to contain inflation.

In a speech to CBI members in the West Midlands last night Mr George said interest rates would be used to maintain price stability and ensure that the economy expanded at a sustainable pace.

'You wouldn't expect me, then, to rule out the possibility of some further rise in interest rates at some point ahead,' he said. However, in his view inflation expectations in the financial markets were overdone.

The Governor said monetary policy was directed at making sure demand was pumped up beyond the supply capacity of the economy. Growth this year had been too strong to be sustainable, which was why interest rates had been raised last month.

Mr George said: 'There are relatively few immediate signs that inflation is about to pick up strongly.' But it was still too soon to be sure that the increase in base rates by half a point to 5.75 per cent had been enough.

The Chancellor also sent a reassuring message on the economy in a parliamentary reply at question time. Kenneth Clarke said: 'We will be able to keep interest rates down, and still consistent with our monetary policy, if we act in good time, if our fiscal policy is sound and if we keep on the course that we have now set.'

Yet new figures published by the Confederation of British Industry showed pay settlements in the third quarter had crept to their highest level in two years. Manufacturing pay awards averaged 2.9 per cent, up from 2.8 per cent in April- June. In the service sector average settlements rose to 3.4 from 3.3 per cent.

Nearly two-thirds of settlements in manufacturing during the year to 31 July fell in the range 1.5-3.5 per cent. In private sector services two-thirds lay between 1.5 and 4.5 per cent. A tenth of settlements involved a pay freeze - half as many as in the preceding 12 months.

Howard Davies, director- general of the CBI, said: 'While the increase in pay awards is marginal, the slight upward shift over the past six months gives cause for concern.' City economists agreed.

Glenn Davies, chief economist at Credit Lyonnais Securities, said: 'We have now had a series of disturbing signs on pay. In the longer run it is wages that determine inflation.'

Kevin Darlington, UK economist at Hoare Govett, said: 'It is clear that pay settlements are heading up and people are beginning to get a bit more than the rate of inflation. You can't blame the markets for worrying about where it will end up.'

Mr Davies said that industry expected further productivity increases, so the cost of labour per unit of output was likely to continue falling, but unit costs were falling even faster in key competitors such as Germany and the US.

Yesterday's figures 'reinforce the need for employers to curb the upward creep in pay awards in the year ahead'.

The gilts market was buoyed by the official remarks on interest rates.

Long-term gilts closed about a point higher. The FT-SE 100 index went along for the ride, rising 29.7 points to 3,029.6.

Dealers remained nervous, however, waiting for third-quarter figures on US gross domestic product today and the outcome of next Wednesday's monthly meeting between Mr George and Mr Clarke.

View from City Road, page 33 (Photograph omitted)