The UK economy continues to show strong steady growth aided by recovery in the main European markets...
The UK economy continues to show strong steady growth aided by recovery in the main European markets of France and Germany. Economic growth is expected between 2.5% and 3% this year and next and inflation is being closely watched by the MPC.
Like the US, the labour market is tight in certain areas and wage inflation remains the major threat to the economy. Sterling's strength against the euro has clearly been a help to the MPC in cooling the economy at the expense of British Industry and this remains the wild card in the Treasury's calculations. In the current political climate interest rates remain the only tool to dampen demand and this has caused sterling to rise to the equivalent of over 3.40 Deutschemarks to the pound. Although positive for manufacturers, a sharp recovery in the euro, would be the most serious threat to inflation and interest rates at the current time, However with real rates still high, MPC policy remains ahead of the curve.
The UK gilt market remains robust. With Government finances in good shape as a result of the positive economic climate and the recent £22.4bn windfalls from the mobile licence auction, supply is likely to remain limited and institutional demand will result in a continuation of the squeeze in long dated paper.
The German bund will continue to be a major influence on the UK bond market as with the MPC committed to nailing inflation, the anchor of joining the euro will remain a major factor. Short sterling is suggesting a peak interest rate of 7% in 2001 which continues to look like a realistic outcome.
Although there remains the potential for surprise in international bond markets, the UK's market remains well placed on a medium term view.
Interest rate rises are inevitable, but I would remain confident that the MPC will continue to manage economic policy successfully for the foreseeable future. Global interest rates are on the rise.
This is the unpalatable but inescapable fact that faces the world's financial markets. The unprecedented period of economic expansion in the USA, which has powered the global economy for the past decade has being joined by recovery in Europe and Japan. While the global economy needs the EU and Japanese economics to pick up the baton of economic growth. the US still shows no sign of cooling down, putting pressure on global interest rates and inflation.
The 'new paradigm' of non-inflationary economic growth due to technology, a productivity miracle, the internet and global competition could be blown off course.
The consensus in the market is that a 0.5% rise in rates will be enough to dent consumer confidence and return the US economy to equilibrium without causing a recession.
Chris White is senior investment manager at Johnson Fry
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