Major and Clarke want interest rates to follow German lead

PROSPECTS of a fresh interest rate cut in Britain increased sharply yesterday after the German Bundesbank lowered its key discount rate by half a percentage point amid mounting evidence that Kenneth Clarke, the Chancellor, wants a further reduction at home.

John Major and Mr Clarke had been contemplating a full half-point cut earlier this month but were persuaded by the Bank of England to limit the change to a quarter point, it emerged yesterday.

Eddie George, the Bank's Governor, is said to have strongly resisted such a deep cut at his crucial monetary meeting with the Chancellor on 2 February, six days before the compromise reduction to 5.25 per cent.

Yesterday's Bundesbank decision took the German rate to the same level. However, it was accepted in Whitehall that, with the Chancellor and Prime Minister united on interest rate policy, there was no question of the Bank being able to resist further cuts if the Government decided to move again.

The Bank argued two weeks ago that the recovery was strong enough without the extra cut and an interest rate reduction might carry inflationary dangers. That view has been undermined since by the unemployment and spending figures released this week which show the recovery could be faltering. In addition, underlying inflation of 2.8 per cent was better than the Bank had expected.

The German reduction, which triggered a wave of cuts elsewhere in Europe, pushed the pound a pfennig higher to a closing DM2.5552 and prompted a flurry of speculation that another quarter-point cut in UK base rates could emerge in weeks rather than months.

The Chancellor's ability to chop base rates further will improve if sterling remains firm against the mark and other European currencies. He may be helped by forecasts of further deep reductions in European rates in the coming year.

The Bundesbank justified its reduction, the first since 22 October, by pointing to German inflation's improving outlook, the mark's recent recovery against the dollar, and persistent recession in west Germany. Although German rates are expected to head significantly lower, it is understood that Bundesbank policymakers favouring a cut faced a strong minority against the move. That suggests the pace of future reductions will be slow, with another drop unlikely before April or May.

The rate cut may help to defuse tensions at a Group of Seven industrialised countries' meeting on 26 February, when US officials are expected to push for faster cuts in Europe to help the world economy.