Slowdown boosts Clarke's case

Kenneth Clarke's case for keeping interest rates unchanged when he meets Eddie George, the Governor of the Bank of the England next week, was strengthened again yesterday by signs that both the British and US economies were weakening more than expected.

Marked slowdowns in manufacturing activity in May were indicated by purchasing managers' surveys in the US and the UK. The magnitude of the fall in the US index came as a real shock to the markets. It dropped from 52 in April to 46.1, its lowest level since May 1991, when the economy was just emerging from recession.

Another sign that the US "soft landing" may be turning bumpy came with the initial jobless claims for the last week of May, which at 389,000 were higher than at any time for a year and a half. According to the US Labor Department, the four-week moving average was the highest since mid-October 1992.

The growth in personal incomes of 0.3 per cent in April was also smaller than at any time since November, the Commerce Department said. In the four months from December to March, monthly increases ran at between 0.5 and 0.8 per cent.

Stuart Parkinson, international economist at Morgan Grenfell, said: "The gathering weight of evidence that the economy is weakening will pile on the pressure for the Fed to ease interest rates."

He points out that when the Federal Reserve first eased policy in the last economic cycle, in 1989, the economic background was strikingly similar to the current one. Such a change might occur when the policy-making committee of the US central bank next meets on 5 July.

In Britain, the monthly Purchasing Managers' Survey also indicated a sharp slowdown in manufacturing. The index, a composite designed to measure the general state of the manufacturing economy, fell quite sharply from 55.4 in April to 52 in May. This indicates that industry is only barely expanding: a reading below 50 indicates recession.

"Thinning order books, particularly from the UK market, have put the brakes on the momentum of growth in manufacturing," said Peter Thomson, director-general of the Chartered Institute of Purchasing and Supply, which publishes the survey.

The fall in the index is significant because it tends to back official statistics that have shown a stagnant manufacturing sector in the first quarter of 1995. By contrast, industrialists replying to the CBI monthly survey have been consistently more upbeat about recorded and future output levels.

New orders fell for the first time since January, due mainly to a further slackening in domestic demand. Output and employment indicators also fell back significantly.

Despite the evidence that manufacturing is slowing, there will be something in the survey for Eddie George's view that a rise in interest rates is needed to stop inflation from taking off again. Prices fell back from their peak in April. However, the price index remained at its second- highest level since the Purchasing Managers' survey began four years ago.

Import prices continued to rise as a result of the weakness of sterling. And higher prices were reported for a wide variety of goods in short supply, including steel, paper and rubber.

Attention now will turn to the US employment report today. After the fall in non-farm payrolls in April, the market expects a rebound of more than 150,000. Anything less will add to pressure for lower interest rates.