INTEREST-RATE speculation undermined sterling yesterday as further

evidence emerged that manufacturing output is continuing to lag behind

the rest of the economy. Much of the blame for this can be laid at the

door of Continental Europe, which is still recession-bound.

Trade figures last week showed that exports to the EU had declined in

each of the three months to November. Any recovery on the Continent is

likely to be delayed until the second half of this year, and it will be

1995 before Britain's manufacturing industry can expect much of a boost

from this source.

Some pundits argued that a 0.5% decline in manfacturing output in

December painted a gloomy enough picture to raise expectations of a cut

in UK interest rates.

The foreign exchange markets feared they might be right and the pound

lost the better part of two pfennigs against the German mark. The talk

of lower interest rates sparked off a rally in share prices, and, with

some help from Wall Street, the FTSE-100 share index gained 29.7 points

to 3393.2.

The indications from Frankfurt were that the Bundesbank council would

leave German interest rates unchanged after its regular meeting on

Thursday. Above-target money supply growth and labour unrest in the

engineering and metal industries seem to have put the lid on earlier

hopes that the German central bank had enough leeway to reduce its key

rates for the first time since October 22.

The retail sales figures for January, which will be published this

morning, are likely to be a much more significant indicator than

manufacturing output. Despite anecdotal evidence that High Street stores

had enjoyed a good Christmas, the volume of retail sales dropped by a

seasonally adjusted 0.2% in December.

Independent economists pointed out that the seasonal adjustment is

distorting official figures for retail sales in December. Most expect a

significant recovery in January in line with what happened last year,

notwithstanding the CBI's survey evidence that retail sales growth has

slowed down.

If tomorrow's retail figures show weakness, the pressure will begin to

build up for the second quarter-point reduction in interest rates.

December's decline in manufacturing output was the first since August

and was partially explained by mitigating circumstances. Tobacco

production had risen strongly in November in anticipation of the

imposition of higher excise duties in the Budget. This process was

reversed in December.

There was also the usual confusion over the Christmas holidays, which

affects production, especially in the steel industry.

In any event economists and statisticians are always reluctant to draw

too many conclusions from one month's figures. Instead they rely upon

three monthly trends.

Here the picture is more encouraging. Manufacturing output rose by

0.5% between the third and fourth quarters of last year and was 2.2%

higher than in the final quarter of 1992. Taking last year as a whole

manufacturing output grew by 1.9% compared with 1992.

Manufacturing is just one component of industrial production, which

fell by 0.6% in December in reflection of a fall in electricity and gas

output because of the milder weather.

However, in the final-quarterindustrial production rose by 1.3% and

was 3.5% higher than in the fourth quarter of 1992. Overall, the

production industries raised their output by 2.7% between 1992 and 1993.

The relative strength of the industrial production figures owes a good

deal to record oil and gas production. In the fourth quarter, oil and

gas extraction increased output by 10% over the previous quarter as

several new oil and gas fields which recently came on stream reached

full production and more new fields came on stream. The previous peak

had been in the first quarter of 1987.

Conversely, coal production fell by a further 7.7% in the fourth

quarter. Mining and quarrying, which includes oil and gas extraction,

increased its output by 7.6% in the final quarter and was 15.2% higher

than in the same quarter of 1992.

Despite the slowdown in December the output of the electricity, gas,

and water industries increased by 1.7% in the fourth quarter and was

3.6% above the level of the final quarter of 1992.

The weakness in the manufacturing sector was concentrated in its

largest component, engineering and allied industries. With export

markets weak, output fell by 0.7% in the fourth quarter and was just

0.8% above the level of the final quarter of 1992. A fall in the output

of the computer and areospace industries was an important factor in the

disappointing manufacturing figures for December.

The best performances were in the coke, mineral oil refining, and

nuclear fuel industries where output increased by 7.6% in the latest

quarter and the food, drink, and tobacco industries, which increased

production by 1.3%.

Overall, the manufacturing picture is rather too mixed for comfort.

The trend is still upwards, but only moderately so.