Interest rate sentiment in U.K. financial markets, which are trading in the shadow of one of the closest fought elections this century, has swung so that some analysts now expect a half-point cut near the March budget release.

This is a change from the situation late last year when traders feared that German rate rises, against the background of a weak pound, would force a rise in U.K. rates.Analysts are now divided. They think that either Chancellor of the Exchequer Norman Lamont will cut rates around his March 10 release of the 1992-93 (April to March) budget, or that rates will remain unchanged ahead of the election that must be held by July 9, and could be as early as April 9. U.K. base rates are currently 10.5 percent.

John Shepperd, S.G. Warburg's U.K. economist said he could see the possibility of cut in U.K. rates around the budget. He said the catalyst would be a change in the market's perception about German interest rates.

At present, the general view on German rates seems to be that they have peaked, but Mr. Shepperd said that in the next few months markets will begin to speculate about the magnitude by which German rates are likely to come down. Warburg is forecasting a cut in German rates in April or May.

The German Lombard rate (for transactions between banks) is currently 9.75 percent and the discount rate is 8.0 percent. The German futures market is beginning to discount a reduction in German rates, with the March and June Euromark contracts trading at implied yields of 9.37 percent and 8.92 percent respectively. German cash money market rates are around 9.5 percent for 3- month money.

Mr. Shepperd said the U.K. government seems prepared to relax fiscal policy. There has been a lot of speculation that the budget would reveal a 1- percentage-point cut in the United Kingdom's 25 percent basic tax rate. He said it was therefore reasonable to look for an equivalent easing in monetary policy.

If the budget were seen as politically beneficial to the government, then a rate cut "might not be seen as particularly disastrous from the markets' perspective," Mr. Shepperd said. David Owen, economist at Kleinwort Benson, however, believes the risks of a rate cut are too high.

"The currency could come under intense selling pressure given the closeness of the election . . . and from the government's point of view they would much rather have tax cuts than risk having to reverse an interest rate


Mr. Owen argues that a tax cut in the budget would have a much more immediate impact on voters than another rate cut which takes a long time to feed through.

Chris Dillow, economist at Nomura Research, agreed that a rate cut is not on the agenda. "There is no scope for a reduction; the only question is will the government be able to get away without increasing them.

"Sterling is not strong enough for a cut and could easily weaken sufficiently to force a rise . . . The most important factor at the moment is politics," Mr. Dillow added.

Simon Briscoe, economist at Midland Montagu believes that "as things stand at the moment the next move is going to be down." But he believes the United Kingdom will have to wait until more traders are convinced that German rates are going to fall before there will be scope for a U.K. cut.

However, he added that if the U.K. budget is particularly well received it might be possible to cut rates shortly after it is delivered.

He said the currency is a constraint, but the hesitancy of the U.K. economic recovery provides an economic argument for reducing interest rates.

Helen Dunn, Lehman Brothers International's U.K. economist, takes the view that while there was "a small chance of a rate cut around the budget, we think it's too risky: the benefits wouldn't come through in time."

Ms. Dunn said that a 50-basis-point reduction in base rates might not persuade U.K. building societies, the main purveyors of mortgage finance in the United Kingdom, to cut their lending rates again. The U.K.'s main mortgage-lenders surprised the markets by cutting their lending rates by around 0.5 percent earlier this month. They normally cut their rates only in response to a base rate cut. Ms. Dunn does not expect rates in the DUnited Kingdom to start coming down until the second half of 1991.