A price to pay for holding out on interest rates

COMMENT: `If Britain had an independent central bank, base rates would climb by a quarter point to 6 per cent this morning. Would there be any suspicion that the election cycle was more important than setting the right interest rate policy?'
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It is easy to forget the closeness of the link between the level of US interest rates and UK base rates. This autumn looks like being one of those episodes when the paths diverge for a short while. It happened last in 1994. The Fed increased rates over there from February onwards. Kenneth Clarke opted for one more cut over here, until he reversed it in September.

If the Fed does increase the target Federal Funds rate today, as many analysts expect, while the Chancellor leaves base rates unchanged, the gap between the two will be the narrowest for more than a decade. This is likely to have two market consequences. First, the pound might come under pressure in the run-up to the election. It has been well-behaved recently, but a smaller interest rate differential will leave it vulnerable to a new bout of political uncertainty or the next EMU row.

Second, there will probably be a price to pay at the long-term end of the interest rate spectrum. Gilts have underperformed other government bonds, in the financial markets' verdict on the UK's inflation outlook. They will underperform by more if the Chancellor has, as expected, turned down the advice of the Governor of the Bank of England. This advice will not be public for another six weeks, but Eddie George is widely thought to have urged a cautionary quarter-point rise in base rates on Mr Clarke.

Does it matter that there is a small price to pay in terms of policy credibility for a decision that many people will agree with the Chancellor to be finely balanced? After all, evidence on the economy is somewhat mixed, with industry lagging behind the consumer recovery.

To see that the answer is yes, turn the question around. If Britain had an independent central bank, base rates would climb by a quarter point to 6 per cent this morning. Would there be any suspicion that the election cycle was more important than setting the right interest rate policy? An independent Bank of England would need to be made politically accountable but other countries have managed that. The case for the Bank's independence grows stronger with every day Mr Clarke holds out.

Heseltine's big idea is a dangerous one

The trouble with Michael Heseltine's Deregulation Task Force has always been trying to decide whether it is a sinister attack on the rights of every employee and consumer in the land or an exercise in the utterly fatuous. As an example of inspired policy-making, it sits somewhere between the Citizens' Charter and Back to Basics as either a total irrelevance or a positive menace.

But, as with all big ideas dreamt up by Cabinet ministers these days, nobody quite has the heart to do the decent thing and give it a proper burial. Like the Private Finance Initiative, the deregulation initiative is dusted down every year, given a new lease of life and relaunched on an unsuspecting world.

There are many areas of commerce and everyday life where deregulation and liberalisation have brought huge benefits without undermining consumer protection or employee rights. Yesterday Francis Maude, who took on the chairmanship of the Task Force when he lost his proper job in politics (he used to be Financial Secretary) named a few of them. Deregulation, he said, had brought us Sunday trading, all-day pub opening, better telephones and cheaper air fares.

This is all true. Sadly, however, none of this had anything to do with his Task Force. Denied the opportunity to deregulate in those areas of the economy that are the province of others, the Task Force is instead left to hack away at red tape in areas which are plain silly or plain dangerous.

Thus, on the one hand we have a proposal to relax the licensing requirements on people who make a living out of body piercing and, on the other, a proposal to remove a swathe of employment rights from those working for small firms.

The Task Force has also introduced us to the concept of risk pricing as an alternative to regulation. Thus, instead of having detailed regulations on the safety of industrial machinery, insurance companies would be left to set standards through the policies they devise and the premiums they charge.

It must have occurred to someone at the Task Force that this might lead to bigger premiums. Economy of thought was not, however, in much evidence in yesterday's outpourings. The Task Force might be committed to cutting down on paperwork but it still took four press releases and two glossy reports yesterday to spell out what it is up to.

No need for small investors to panic

Asked what he thought the market would do that day, JP Morgan once said: "It will fluctuate, boy, it will fluctuate." He meant that neither he nor anyone else could hope to know where the market was headed in the short term. Implicit in his quip was the message that in the long run it doesn't matter - he would have lost no sleep over yesterday's 44-point fall in the All Share.

Since 1919, a time period long enough for even the most persistent statistical blips to be ironed out, shares have outperformed other financial instruments by such a wide margin that it is a wonder that anyone bothers investing in any other asset.

The real return of 8 per cent for shares compared to under 2 per cent for gilts represents a mind-boggling difference when compounded year after year for more than three quarters of a century. It is a statistic that should be remembered while reading the panicky gloom-mongering currently masquerading as market commentary. For the long-term investor, whether to be in or out of equities is an idle question.

The bearish stance being taken by Tony Dye of PDFM may well be borne out in the long run. But that is of little relevance to small investors. Catching the peaks and troughs is beyond even the best-paid fund managers. For other investors it is a futile strategy. Apart from the sheer impossibility of timing moves that well, the cost of bouncing in and out of shares makes the exercise largely counter-productive.

After the cost of commission on the way in, the effect of the bid-offer spread and the price of selling again, a share has to appreciate by at least 5 per cent, and often by much more, just to wash its face. Sensible investors, such as the American tax inspector who retired in 1945 with $5,000 and died last year with $22m, buy and sell shares as infrequently as they can.

The trick in jittery markets like these is not to panic: continue to buy shares in genuine growth companies with low ratings relative to their high and sustainable earnings growth rates. Look for the support of good cash flow and ride the momentum of shares that are already outperforming the market. Most important, stop worrying about the market which will continue to fluctuate, boy, fluctuate.