Tax increases fail to damage UK recovery: No change in interest rates expected as banks record rise in money supply

THE Chancellor of the Exchequer and the Governor of the Bank of England are expected to agree today to leave interest rates unchanged for at least another month after evidence yesterday that tax increases have not yet damaged economic recovery.

The Bank of England reported the biggest rise in the narrow money supply measure M0 - normally an indicator of high-street spending - in 13 years, while house prices and mortgage lending by large British banks both rose. Business failures fell last month while inquiries to the construction industry about new work rose for the first time in five years.

But there was mixed news on inflationary pressures in the labour market, with the Confederation of British Industry reporting a rise in pay settlements in manufacturing industry to an average 2.7 per cent in the first quarter of the year and a fall in service sector settlements to an average 2.4 per cent.

Despite the fading hopes of a cut in interest rates, the pound slipped amid nervousness ahead of tomorrow's local elections. The pound fell 0.7 to 79.6 per cent of its 1985 value.

M0 - cash plus banks' balances with the Bank of England - grew by an unexpectedly sharp 1.9 per cent in April, the biggest monthly increase since 1981. This took the annual rate of increase to 6.2 per cent from 5.6 per cent in the year to April, well above the Treasury's 0-4 per cent 'monitoring range'.

City economists warned that the figures might have been inflated by the difficulty of seasonal adjusting around Easter, while the Treasury argued that M0 growth was being boosted by low interest rates, which reduce the incentive to hold savings as interest-bearing deposits instead of cash. John Marsland of UBS said M0 was probably still within the monitoring range after taking account of the level of interest rates, but that it could be signalling a resurgence of inflation next year.

'This is the first indication of how personal spending is holding up following April's tax increases and, so far, it appears to have maintained its strong recovery,' said Adrian Cooper of James Capel.

The British Bankers' Association added that the tax increases did not yet appear to have damaged the confidence of housebuyers. Gross mortgage lending by the major British banks rose by 46 per cent in March to pounds 1.5bn, although the BBA said much of the rise was seasonal.

The Nationwide Building Society reported that house prices rose 0.2 per cent in April to give an annual increase of 2.9 per cent, with the average house price now at pounds 53,853.

'There is so far little evidence, either from house price movements or from our latest lending figures, that the tax increases implemented in April are causing the modest housing market recovery to stall,' said Tim Melville-Ross, Nationwide's chief executive.

There was also good news on prospects for industry, which isless directly affected by the tax rise.

The Royal Institute of Chartered Surveyors said that inquiries to the British building industry about new work rose 2.5 per cent in the three months to 31 March, the first increase in nearly five years.

Touche Ross, the administrators, reported a fall in the number of business failures from 262 in March to 171 in April. But this was typical for the time of year and Touche Ross said failures appeared to have flattened off, but at a higher level than before the recession.

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