Unchanged rates lift economic mood

Financial markets are capricious beasts. A couple of months ago, the feeling in the City was that interest rates - which had risen from 5% to 6% during the autumn - were set to go much higher this year. The most pessimistic analysts and dealers were betting on the cost of borrowing hitting at least 7% this year and heading further upwards in 2001.

With the Bank of England leaving rates on hold today for the fourth successive month, the mood has now become a lot less gloomy. Some City experts still believe that the Bank will feel the need to damp down the economy over the coming months, but only with one or two quarter-point increases.

The recent fall in the value of sterling, while welcome for exporters, will add to pressure on the Bank's monetary policy committee (MPC) to increase interest rates, because it has the effect of making imports dearer. However, provided the pound does not fall too far or too fast, the MPC should remain relatively relaxed.

Indeed, it is possible that the next move in interest rates may be down rather than up, if the recent moderation in house-price inflation, the weakness of manufacturing output and the slowdown in the pace of economic growth all persist throughout the summer.

Inflation has been below the government's 2.5% target for almost a year, and it will take evidence that the tightness of the labour market and the lower pound are actually feeding through into higher prices in the shops to force the MPC's hand. Thus far, such evidence has been pretty hard to find.