Slowdown fears as lending weakens: Tiny rise in loans from banks and building societies combines with futures selling to send shares sliding

FEARS that the economy is slowing amid nervousness ahead of April's tax increases intensified yesterday as the Bank of England published figures showing bank and building society lending much weaker than expected.

This helped to depress the stock market, which was also under pressure from sliding world bond markets. The FT-SE index of 100 leading London shares closed 42.7 points lower at 3,382.6. Share prices were dragged down by heavy selling on the futures market, with light trading on the cash market.

Bank and building society lending rose by just pounds 200m last month, the lowest monthly figure for more than a year and well below the average forecast of pounds 2.4bn. This followed very strong lending in December, with the six-month moving average showing a flat or gently rising trend.

Don Smith, of Midland Global Markets, said lending had been surprisingly low in January, partly because companies were using improved cash flow rather than borrowing to make the heavy corporation tax payments that are normal for the time of year. 'Continued corporate sector aversion to debt is certainly not encouraging for recovery prospects,' he said.

The broad money supply measure M4 - cash plus bank and building society accounts - rose by a seasonally adjusted 5.5 per cent in the year to January, barely up from 5.4 per cent in the year to December.

Broad money growth remains in the bottom half of the Government's 3-9 per cent target band. In part this is because the Bank has been selling more gilts than it needs to sell to meet the public sector borrowing requirement. Companies have also chosen to raise funds from bond and equity issues rather than bank borrowing. 'The result has been an apparent lack of growth in broad money, while the cash value of national output has bounced,' John Marslan, of UBS, said.

The Building Societies Association reported the first January net ouflow of funds from building society accounts on record. The BSA blamed this largely on funds being withdrawn to buy the 'granny bond' announced in the Budget. The outflow amounted to pounds 265m, up from pounds 121m in December.

Personal borrowing picked up from pounds 597m in December to pounds 675m in January, according to the British Bankers' Association. But economists said the disappointing economic data this week suggested that a further base rate cut might be needed to keep high street spending on track once tax increases bite. Figures earlier in the week showed the biggest rise in unemployment for a year, a fall in manufacturing output and an unexpectedly weak rebound in retail sales.

Hopes of lower interest rates in Britain did little to help the gilts market, with world bond markets suffering another bout of selling led by hedge funds and other aggressive investors in the US - many of whom had sustained uncomfortable losses in futures markets.

Analysts said European markets were ignoring continued good news on inflation in their own backyard and the prospect of further falls in European interest rates. They were transfixed instead by the fear of US interest rates rising further. Gilts, German bunds and French bonds fell, but the Italian market resisted the trend. Long gilt futures dropped sharply in late trading as the US debt futures market hit a new low for the year.

George Magnus, of Warburg Securities, said the selling did not reflect worsening inflationary fundamentals, which suggested that bond yields should fall again in time. He said the markets were pricing in higher risk premia that did not suggest an enduring bear market, although German money supply figures and the testimony of the chairman of the US Federal Reserve, Alan Greenspan, to Congress did not bode well for the short term. 'Next week could be very difficult for the markets,' he said.

Nick Stamenkovich, of DKB International, agreed that the weakness in European bonds was likely to be temporary, but said it was difficult to see what would allow the markets to turn the corner. 'The key is that the domestic background in Europe has not changed,' he said.