Pressure to raise rates: Bank ready to move if pay deals soar

THE BANK of England may press the Chancellor of the Exchequer for a rise in interest rates as early as this week if further evidence of accelerating pay deals undermines the credibility of the Government's inflation target, some City economists believe.

The Chancellor will use his Mansion House speech on Wednesday to emphasise that the sustainability of economic recovery depends on keeping inflation low. This demands prudent use of interest rate policy and measures to enhance the flexibility of the economy along the lines of those proposed last week by the Organisation for Economic Co-operation and Development.

Darren Winder, UK economist at Warburg Securities and a former Bank of England official, said it would not be surprising if the governor of the Bank had urged Mr Clarke to raise rates this week, making a pre-emptive strike to establish anti-inflationary credibility. 'After the European elections, it would allow him to take all the bad news at once,' he said.

David Miles, a former Bank economist at Merrill Lynch, said it was 'not a crazy suggestion' that base rates could rise this week.

'If Wednesday's earnings growth figures are a good bit above 4 per cent the Bank might be lobbying for a half-point rise in base rates now.' However, he thought the Treasury would be more likely to block moves for an early rise.

A host of economic indicators are due this week, with the markets probably looking most closely for any movement in annual average earnings growth from March's 4 per cent. Headline inflation is expected to have crept up to 2.5 per cent last month. Both figures are due on Wednesday.

Several leading economists are warning that base rates will have to rise sharply next year to head off rekindled inflation pressures and a weakening pound. Some predict that base rates could rise to between 7 and 10 per cent by the end of 1995. With the economic expansion much stronger than realised, growth could hit 3 per cent this year and accelerate even more in 1995.

This is in line with the latest published forecast on the British economy by the OECD.

The unexpectedly good news on inflation and growth should give the Chancellor room for manoeuvre on public spending. But some observers expect him to demand dramatic early results from the fundamental reviews of public spending - perhaps cutting as much as pounds 10bn from spending plans within three years. This would please the Tory right wing, create scope for tax cuts and perhaps ward off base rate rises. But some economists are still gloomy about the Chancellor's long-term room for manoeuvre.

''Persistent trade deficits are adding to the economy's overseas debt and debt servicing costs, further undermining Britain's weak balance of payments,' Bill Martin of UBS said. 'Long before the debt blows up, sterling is likely to sink, forcing a crisis jump in interest rates. We forecast 10 per cent base rates by the end of 1995.'

Kevin Gardiner of Morgan Stanley is less bearish about the medium-term outlook for the economy. Over the next few years he predicts the fastest growth rates since the late 1980s. But he warned: 'Monetary policy at present is loose and a substantial tightening could be justified simply to arrive at a situation - as in the US - in which interest rates correspond more closely to long-run inflation expectations. A base rate of 7 to 8 per cent is necessary, we'd argue, simply to achieve 'neutrality'.'

Robert Chote, page 8