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Sterling strength keeps interest rates low

The strength of the pound has once again brought Kenneth Clarke intoconflict with the Bank of England over interest rate policy.


Any acceleration in UK economic activity will be of considerable benefit to corporate profits and dividends, but will bring with it the risk of an increase in inflation and therefore higher interest rates. Towards the end of 1996, investors focussed on this latter factor.

Despite expectations of a pick up in consumer activity in late 1996 and 1997, share price performance of retailers has been poor. This has been partly due to institutional investors restructuring portfolios towards manufacturers. Although trading momentum is still healthy, it is not living up to expectations which were particularly inflated over the Christmas trading period.

The largest rights issue during December 1996 was the u173m raised by Allied Colloids, the chemical company, in order to purchase the US-based CPS, which gives them greater access to the American market. The deal also affords Allied Colloids the opportunity to expand its product range, lower manufacturing costs, and increase its raw material purchasing power.

The US market has continued to confound those who have deemed it to be overvalued. Mutual fund inflows and strong corporate fundamentals have led the market higher. In contrast, the Japanese economic recovery has been sluggish, something which continues to worry domestic investors.

Current rising unit labour costs in the manufacturing sector are a sign of incipient inflation. Recent UK inflation figures have suggested that the government will find it difficult to meet its inflation target. Investors have therefore largely been investing in sterling in anticipation of rising short-term interest rates.

The Bank of England remains worried about inflationary pressures and wants interest rates increased. However, the strength of sterling has allowed Kenneth Clarke to make a stronger (and so far successful) case for maintaining them at their current levels; there is a good chance that they won’t be increased before the election. The UK economy is set to have grown by 2.3% in 1996, and is forecast to grow by 3.5% during 1997

The strong technical support and international money flows that have recently pushed up sterling could well continue for some time. It is expected that sterling will depreciate if there is a period of higher inflation, a deteriorating current account, or even a pickup in global economic activity

Information supplied by Scottish Amicable Investment Managers: 0141 303 0000

Earnings figures are for quoted non-financial companies and are those earned (rather than reported) in the stated year.

Dividend figures are for the FT-SE Actuaries All-Share index and are those reported up to end-April of the following year.


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