Interest Rates: Decision forced by strong growth: Why now? Robert Chote examines the background to the rates move and finds Kenneth Clarke apparently determined to break the old pattern

NIGEL LAWSON wrote in 1962 that the Treasury's actions always fell neatly into one of two categories: too little too late, or too much too late. Mr Lawson himself acted too late when he presided as Chancellor over the 1980s boom, but yesterday's base rate rise suggests that Kenneth Clarke is determined to break the pattern.

Since 1981 there have been 10 occasions when Chancellors have pushed up interest rates for the first time after a series of cuts. On all but one, they were forced into it by the financial markets - almost always because the pound had been under attack on the foreign exchange market.

Yesterday's rise, however, was different. There was little pressure from the City and no single piece of new information suggesting an imminent crisis. Mr Clarke said he was acting early to ensure that economic recovery was not derailed by rising inflation, as it had been so often in the past. 'If anyone was surprised that I should be raising rates in the autumn of 1994, I am not sure why,' he said.

Yet the decision was a surprise in both the City and Westminster. Opinion was predicting a late rate rise, not an early one. The recovery appeared to be losing steam, August car sales had been disappointing, retailers were pessimistic about high-street spending and the housing market was struggling in the face of tax increases and higher interest for fixed-rate mortgages.

Given these factors, neither the Chancellor nor the Governor of the Bank of England found the decision easy. Just a week after his return from holiday, Mr Clarke saw the governor last Wednesday morning at their regular monthly meeting. The discussions, lasting an hour and 20 minutes, failed to come to any firm conclusions.

Eddie George, the governor, told Mr Clarke the time had almost certainly arrived for an increase. The bank argued that recent revisions to gross domestic product figures meant that the economy was running closer to full capacity than it had thought. It said this 'output gap' was apparently closing more quickly than had appeared to be the case early in the summer.

Bank officials said they had already detected that demand was outstripping the capacity of some industries, such as construction and building materials. In these areas upward pressure on prices had already begun to appear.

The GDP figures showed that the economy had grown by 3.7 per cent in the year to the second quarter, or by 3 per cent if buoyant North Sea oil and gas production was excluded. This was outstripping the 2 to 2.5 per cent that the economy has been able to sustain on average in recent years.

The Central Statistical Office also revised up earlier data, showing the recession had not been as deep as it thought and that the recovery also had been stronger than first estimates had suggested. Senior Treasury officials are concerned that these figures may still underestimate the pace of growth. Alternative measures of growth - counting spending and incomes rather than output of goods and services - also suggest that the recovery could be more robust than the headline figures suggest.

The rapid recovery has left the bank more worried about the long- term inflation prospects than it was when it published its quarterly report on anti-inflation policy last month - even though its short-term forecasts have again proved overly pessimistic. Mr Clarke is committed to holding underlying inflation - excluding mortgage interest payments - to between 1 and 2.5 per cent by the end of the Parliament in April 1997. He said yesterday that the half-point rise would take at least 18 months or so to have its full effect in restraining growth and inflation.

Mr Clarke accepted that the time to raise interest rates may well have come, but he and Mr George agreed to take a couple of days more to decide whether rates needed to go up imminently. Mr Clarke eventually took the decison after a telephone call with Mr George on Friday afternoon, by which stage it was too late to act before the end of the day's trading in the financial markets.

The decision was confirmed yesterday morning. The bank announced it at 9.45am by setting a 'minimum lending rate' of 5.75 per cent. Most City economists had assumed that as rates had not risen last week, they would not do so at least until after the next monthly meeting between Mr Clarke and Mr George in October.

Senior Treasury officials said that the decision was taken in part to convince the markets, business and the public that Mr Clarke was serious about keeping inflation low. This, they hope, will encourage negotiators to keep pay settlements low.

The markets were also reassured by Mr Clarke's pledge not to cut taxes in this autumn's Budget. However, some remain nervous that Mr Clarke may be trying to get all the bad news out of the way earlier so that he can cut taxes dramatically in a pre-election Budget in the autumn of 1995. Senior Treasury officials insisted that the decision had not been taken with this year's Budget in mind.

Mr Clarke described the rise as a 'slight tightening of policy'. However, some economists say base rates are still low enough to boost spending, and that they will need to rise to about 7.5 per cent before rates are pressing neither on the brake nor on the accelerator.

Most City economists expect rates to rise again early in 1995 or perhaps late this year. Mr Clarke is probably hoping that by acting early he will be able to limit the long-term political damage.