Sir Eddie warns that tax cuts would bring higher interest rates

Sir Eddie George, the governor of the Bank of England, delivered a strong warning yesterday that over-generous tax cuts or further big increases in public spending in today's pre-Budget report would trigger higher interest rates.

Rejecting calls from exporters for specific measures to reduce the value of the pound, Sir Eddie said that the economy was running at almost full capacity and a further tightening in monetary policy could not be ruled out.

He added that inflation would start to rise unless there was a slowdown in the rate of private sector demand growth to prevent a further deteriora tion in the trade balance and accommodate "the public sector expenditure growth which the chancellor has already announced, not to mention whatever he may be planning to announce tomorrow".

Speaking to the CBI annual conference in Birmingham, Sir Eddie said: "There are signs that this slowdown in private sector demand growth may be beginning to happen, but that is certainly not assured - and over-generous tax cuts would not help.

"I must tell you that I am surprised by the billions of pounds that some commentators have suggested the chancellor could safely give away."

Sir Eddie said Britain's long period of economic expansion could continue provided there was low and stable inflation, fiscal prudence and supply-side flexibility.

However, he added that he was aware that many business leaders - struggling with the impact of the strong pound - would conclude that he was "living on a different planet".

Beneath the surface of the encouraging macroeconomic data, there was a serious imbalance between those parts of Britain doing very well - including services and hi-tech manufacturing - and those parts facing the toughest conditions that they could remember.

He said globalisation was one reason for the disparity between sectors, but added that the strength of the pound had also been a key factor. "There is no doubt that some of these effects have been aggravated by exaggerated changes in foreign exchange rates - including the progressive weakening of the euro," he said.

"That is a particular problem for the UK because of the relatively large proportion of our economy exposed to competition from the eurozone.

"Even as a central banker I can understand why many euro-exposed businesses feel hard done by."