Charting a course for higher rates

THE High Street booming, house prices going through the roof. It is as if some time-machine had yanked us back to the mid-1980s. Those who remember how the Eighties boom ended in tears must wonder whether we are set to repeat the experience.

It looks unlikely because circumstances elsewhere are very different. Industry and investment are flat and so is inflation. The rampant consumer is not overheating the economy because a good deal of the money is being soaked up by imports. Yet the imbalances are becoming striking and could become a problem - especially for those hoping for a smooth 'convergence' with euroland.

The High Street news is dramatic. Some 65% of retailers told the CBI that Christmas sales were higher than last year. Only 17% reported them lower. The 48% gap is the highest since 1987. At John Lewis stores, sales soared 17.3% in the Christmas week.

House prices surged 1.9% in December and 13.8% last year, the strongest rise since 1988, says Nationwide. It expects a further 6% this year. With interest rates on the floor, it is hardly surprising. If the Bank of England were setting rates based on housing and the High Street, it would probably hike them to 6.5% or higher.

Global gloom makes that unlikely. But economists are deciding that UK rates have hit bottom and some see them at 5.5% by year-end - bad news for euro enthusiasts.

Europhoria ebbed in the currency markets, where it was another day, another dollar rally. Both the pound and the greenback were calmer, and the European Central Bank retreated into its shell, holding its interest rates at 3.25%.

It was good news for sterling after Wednesday's jitters when its average index plummeted from 107.1 to 105.7 at one point. Last night, it closed just 0.1 lower at 106.0. The euro was barely changed at 62.5p and slid just below 90 US cents in mid-afternoon, leaving sterling worth $1.4380.

Europhiles could do with a respite from the markets, because the chances of interest rates nudging closer to euroland are diminishing. Merrill Lynch currency expert Neil MacKinnon said: 'This pulls the rug from under convergence.'

At present, UK and ECB rates are not insuperably far apart. But HSBC economists see the UK at 5.5% by year-end, double the likely euroland rate of 2.75%.

ECB boss Wim Duisenberg said interest rates were appropriate 'for the foreseeable future'. The Dutchman, scattering hostages to fortune, said he would be 'surprised' if the euro gave up its recent gains.

Most economists think that, with the German economy crawling along in the slow lane, the ECB needs to cut to 2.75% soon and perhaps go even lower. After all, it slashed rates to 2.5% in 1999 and the state of euroland is probably weaker now.

Those who see the single currency as ushering in an era of interest rate stability should look at the past. Rates have moved about quite a bit since the ECB started. Before that, the best guide is German rates, which swung from 8.5% to 3% in the course of the 1990s.

In today's strange world of limbo-dancing central bankers competing to lower the interest rate bar, the Fed's Alan Greenspan leads with 2%. Duisenberg may follow him some way down, but our own Sir Edward George looks set to quit the floor. He will be relieved at the pound's calmer performance. MacKinnon said: 'When the prospects of entry seem to be growing, the market's knee-jerk reaction is to sell sterling. The Government could talk itself into an unnecessary crisis.'

That, too, would be just like old times.