Higher interest rates cool the economy down

New signs that the overheating economy might be coming off the boil encouraged hopes, ahead of next week's meeting of the Monetary Policy Committee, that the Bank of England will not need to raise interest rates much further. Most economists expect the Bank to pause before it increases the cost of loans again.

The latest survey of service sector businesses helped shares in London make further gains yesterday, following Tuesday's record 257-point increase on Wall Street.

Some Asian markets also made sharp recoveries yesterday, with share prices up strongly in Tokyo, Hong Kong and Jakarta. Other bourses in the crisis- hit region remained in the doldrums, however.

The FTSE 100 index ended nearly 25 points higher at 4,976.9, unable to stay above the 5,000 barrier it had breached earlier in the day. Interest rate prospects also took the pound sharply lower. It lost four pfennigs to end at DM2.88, and sterling's index against a range of currencies fell by 0.8 to 100.6.

The Dow Jones index was slightly lower by mid-morning at 7,875.6, with traders nervous about what key figures on jobs and earnings due on Friday will imply for US interest rates. Many predicted a volatile run up to their publication.

"There is quite a bit of flux in the outlook for interest rates. This sort of volatility is not uncommon when the markets have had a good run," said James Barty, an economist at Deutsche Morgan Grenfell.

A growing number of analysts fear Wall Street in particular is overdue for a sharp correction after enormous gains this year.

Yesterday's survey suggested that the four recent UK interest rate increases have started to cool the most overheated sector of the British economy.

Most City analysts leave open the possibility that the Bank of England will take more action later in the year, however. "This week's figures suggest the increases we've had already are starting to have the required impact. That's encouraging, but it doesn't mean the Bank can leave the job on rates half finished," said David Hillier at BZW.

The monthly survey of purchasing managers in services showed that growth in August remained strong, but less strong than the previous month. The index of business activity declined from an uncomfortable 62.1 in July to 58.6. Businesses blamed higher interest rates and the strong pound.

In the Far East yesterday share prices in some markets staged sharp recoveries. The Hang Seng index in Hong Kong gained 979 points to reach 14,713.99, while Tokyo's Nikkei index climbed by 503 points to 18,735.17.