City expects spring rate rise

THE City is still braced for a spring-time rise in interest rates, despite a modest fiscal tightening in yesterday's Budget. Gordon Brown avoided the temptation to embark on a major giveaway ahead of the General Election, instead announcing measures that yielded the Exchequer a net £265m in the 2005-2006 financial year. Speculation ahead of the Budget had centred on a £3bn fiscal loosening.

But robust, economic growth and a lack of spare capacity are expected to force the Bank of England to lift the cost of borrowing to keep a lid on inflation, possibly as early as May.

Economist George Buckley at Deutsche Bank said: 'Markets are still pricing in at least one more rate hike, to 5%, this year. In terms of monetary policy, I don't think the Budget changes much at all.'

Citigroup's Michael Saunders said: 'With a roughly neutral Budget and a roughly neutral overall fiscal stance, the burden of capping the recovery will continue to fall on the MPC (Bank of England's monetary policy committee). We expect the MPC to hike rates by a quarter-point in both the second and fourth quarters this year, with the first move probably coming in May or June.'

If the General Election takes place on 5 May, the MPC meeting would be deferred by 48 hours, with the rate decision announced at noon on Monday 9 May. Minutes of the MPC's February meeting revealed that one member, Paul Tucker, is already pushing for a rise, and others believe an increase 'might be warranted in due course'.

However, Roger Bootle, economic adviser to Deloitte, said the Chancellor's thrift should ease fears that rates have much further to climb. 'Rates could still rise again over the next few months, but even if they do, I expect them to fall in the year as the slowing housing market dampens household spending and overall activity,' he said.

All eyes today will be on February retail sales figures for clues on the extent of the consumer slowdown. Sales volumes are expected to show a modest 0.2% rise after January's 0.9% jump.

However, the cold, wet weather at the end of February means they may have been disappointing. The British Retail Consortium has already said sales were 0.3% lower than a year earlier.

Gilts were expected to come under the spotlight as the market digested news that the Debt Management Office will issue a record £53.5bn of the bonds in the 2005-2006 financial year. Some £18.5bn of this will be at the long-end, including a new 50-year gilt.

Don Smith, gilt analyst at Icap, said: 'We are likely to see some underperformance at the long end, say 30-years relative to 10 years, but I don't think yields will be pushed significantly higher.

M&S could cost Chancellor dear

THE most important tax problem the Chancellor failed to tackle may end up costing him billions of pounds. Marks & Spencer has challenged the Inland Revenue in the European Court of Justice over a refusal to allow the group to offset the cost of closing its Paris stores and other French operations in 2001 against its UK tax bill. M&S claims the Revenue overcharged it by about £10m.

The stores group says the Revenue has unfairly interpreted one of the most important areas of corporate taxation - group relief - which allows companies to use losses in one area to offset gains elsewhere.

While the Marks & Spencer case is relatively small, it is thought that if the Revenue loses it will open the floodgates to claims from numerous other multinational companies, which experts reckon will amount to several hundreds of millions of pounds - if not billions.