Industry relieved but stocks plunge as MPC holds rates

BRITISH INDUSTRY breathed a sigh of relief yesterday after the Bank of England decided to keep interest rates on hold at their 22-year low of 5 per cent.

The decision, widely expected, came hours after new data showed that manufacturing industry suffered a surprise slump in July. But leading shares plunged by more than 2 per cent as analysts said the Bank had only postponed an inevitable tightening in policy to control inflationary pressures.

Shares on Wall Street also fell sharply after data showed that productivity gains had failed to keep pace with pay rises, increasing fears that the Federal Reserve will hike rates this month. However, the Dow later mounted robust recovery.

The Bank's Monetary Policy Committee will not reveal its reasoning until 18 August, but next week sees the publication of the key quarterly inflation report.

The report - and the minutes of the meeting - are expected to show growing concern about accelerating economic growth, implying that the next move for interest rates will be upwards. Hopes of a further cut were banished by recent data pointing to a recovery in the manufacturing sector, a tightening labour market, a boom in service industries and strong growth in the housing market.

However, growing optimism about the state of the economy took a knock from official figures showing that manufacturing contracted by 0.2 per cent last month. The fall - the first since December - disappointed City economists, who had predicted a 0.2 per cent rise.

The Office for National Statistics said output was still 0.4 per cent up on the quarter, and a breakdown showed strong performance from sectors such as pharmaceuticals, which rose 7.2 per cent on the quarter, a record.

The Confederation of British Industry backed the MPC's decision but said weak inflation pressure should "leave the door open" for another cut later in the year.

Sir Ken Jackson, head of the engineering union AEEU, said the MPC was walking a "difficult tightrope" but added: "It cannot ignore that manufacturing is still suffering due to the high pound." The MSF union praised the Bank for ignoring "dangerous calls" from some analysts for a rise.The British Chambers of Commerce said rates should be kept on hold while the economy absorbed previous cuts.

Economists backed the Bank's decision but were split on when rates should rise. Ciaran Barr of Deutsche Bank forecast no rise before 2000, saying the MPC would wait to see wages and house prices boosting consumption. But Philip Shaw of Investec said he had pencilled in two 0.25 per cent rises by the end of the year, pointing to strengthening economic conditions.

The financial markets, which have baffled pundits by pricing in rates of 7.25 per cent - an increase of 225 basis points - by the end of 2000, moved even more bearish. The price of short sterling fell, implying interest rates of 7.3 per cent by December 2000.

The euro broke through $1.08 after a rise in German industry orders and a small rise in the jobless total. Technical analysts said the market would fix its sights on the May high of $1.0841.

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