Gordon Brown, the new Chancellor, delivered promptly the expected rise in interest rates pushing up the base rate by a quarter-point to 6.25 per cent and in an historic move granted the Bank of England independence to change rates on its own. This is expected to produce tighter monetary discipline which will drive the cost of borrowing down eventually.
"Investors are focusing on lower inflation prospects and lower bond yields," said Nigel Cobby, at Morgan Stanley. "It's a good environment for re-rating stocks in general."
Rising bond prices boost the value of the banks' and insurers substantial government debt portfolios. At the same time, lower bond yields mean lower borrowing costs for most companies. "The fundamentals are sound. We seem to be in a low inflation environment with reasonably good growth," said Paul Maguire, at Cannon Lincoln Fund Managers.
Investors will focus this week on the major economic reports for April. Figures on producer prices will be published on Monday, unemployment Wednesday and retail prices on Thursday, which should show the strength of economic growth.
Earnings are due from Cable & Wireless, Safeway, Imperial Tobacco Group and British Telecommunications. In the US, several economic reports are due out before the next Federal Bank meeting to decide on rates on 20 May. They include April retail sales, producer prices and consumer prices this week.
Banks could extend their record gains of last week. The industry group's expansion is forcing institutional investors to increase the weight of bank shares in their portfolios, boosting demand for bank shares.
"Banks are still through the roof and with such a shortage of stock, they are likely to remain in favour," said Martin Lupton, at Dresdner Kleinwort Benson Securities.
Building materials companies such as Redland, RMC and other companies that make a lot of their profits in Germany may gain after the pound fell almost three per cent against the mark last week.
The pound has risen about 20 per cent against the mark since September, prompting a wave of profit warnings from the likes of British Steel and the auto parts maker Vickers.
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