COMMENT : Convergence play leaves Britain out in the cold

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The Independent Online
Of the many bizarre trends in capital markets right now the strangest of all is the dramatic narrowing of the premium on Italian and Spanish bonds over those of Germany. To put it simply, what has been happening is that the cost of Italian and Spanish government debt has fallen to the extent that for the first time it has moved to within 2 percentage points of Germany's. Italy now pays less for its money than Britain. The same is also true of Ireland, Finland and Sweden.

Given that Italy and Spain could until recently be characterised, from an economic perspective, not too far adrift from banana republic status, this would seem to be quite a turn-up for the books. But don't worry. It's only partly to do with economic fundamentals. We haven't been overtaken by Spain, Italy and Finland - yet. Rather the reason is to do with EMU.

Peripheral bond markets are rising strongly in anticipation of monetary union. If markets believe a country will join EMU, it seems reasonable to align their long-term bond yields with those of the lowest denominator - Germany - since after EMU their inflation and currency rates should be the same. In markets, this is known as "the convergence play". The dangers for those who adopt this as an investment strategy are only too apparent.

Even Deutsche Bank, which is about as strongly pro-EMU as they come, is warning that any setback in monetary union "could result in the undoing of recent market trends towards convergence and instead set off a flight to quality".

For the moment, however, these dangers are being ignored. Bond prices in Italy and Spain keep motoring upwards. Much tougher than expected Italian and Spanish budgets have reinforced the view that these countries are both serious about and capable of joining EMU, if not in the first wave, then certainly in the second.

In part, the convergence phenomenon in bond markets is self-fulfilling for the Maastricht Treaty makes it a condition of EMU membership that nominal long-term interest rates converge to within 2 percentage points of the best performing member states. But it is also a reflection of political and economic reality. Because France in particular, and Germany to a limited extent, are also fudging the Maastricht conditions as they race towards monetary union, they cannot be as high-minded as in the past about the cheating ways of others.

The idea of Spain and Italy as early participants in monetary union is as a consequence less of an anathema to Germany than it was. A more relaxed stance on the fudge, together with some real progress on economic convergence, make it highly possible that Spain and Italy will gain entry at an early stage. Britain's position in all this is a mirror image of that of the Southern Europeans. While its politicians continue to talk the language of the Eurosceptic, there's little chance of the gilts market getting swept up in the convergence phenomenon - much to the anguish of the Treasury, for according to a recent report by IBCA, the debt rating agency, the beneficial effects on the cost of Government borrowing could be worth as much as 2p off the basic rate of income tax. The economics argue forcibly against it too. On present Treasury forecasts, Britain is not going to meet the 3 per cent Maastricht ceiling on debt as a proportion of GDP next year. If the Bank of England is right in what it said last week about inflation, Britain may not meet the inflation criteria either.

So although these trends in international bond markets seem hard to understand from a British perspective, even bizarre, there is a modicum of logic behind them. Britain's wait-and-see stance on EMU may ultimately prove to have been the right one, but boy, is it going to cost us if it turns out to have been wrong.

Harrogate and the single currency

Harrogate's outlandish and expensive conference centre has, despite its size, always encouraged a feeling of claustrophobia and when hundreds of company executives are stuffed together into its confined spaces and maze of walkways, it is no surprise that tempers get a little frayed. Little more than eight hours into what was fast turning into a political circus yesterday the delegates could be forgiven for feeling like soft toys pulled around by a pack of ravenous terriers. Michael Portillo, Michael Heseltine, Gordon Brown - the CBI conference this year seems more like political hustings than a business conference.

The overwhelming impression was of any attempt at serious and much-needed commercial discussion put on hold until after the election.

One frustrated delegate who will remain nameless summed the proceedings up thus: "Most CBI people would rather politicians said what they stand for than use the conference to slag off their opponents."

Others complained of inability to plan when so many of the important decisions have yet to be taken.

On the single currency, for example, both main parties are undecided. Not that this does any more than reflect deep divisions within the CBI's own membership. The CBI itself is sitting on the fence on this vital issue for fear of being engulfed by a tidal wave of political flak. With that kind of leadership, it is no wonder that many businesses feel rudderless.

Capital jockeys for a new theme

Capital Radio needed to do something to break out of the present hiatus in its development. But whether things are desperate enough to justify going out and buying a chain of theme restaurants is another thing. It smacks of management that cannot think of anything better to do.

We have heard the "synergy" arguments before. Capital is a strong marketing brand. So it should be able to provide ambiance, good music, pleasant surroundings and thematic food as well, surely.

That was Richard Eyre's argument yesterday, as he unveiled the pounds 51m acquisition of My Kinda Town.

There are some sound arguments in favour of the restaurant trade. Britons still eat out less than their counterparts in big Western countries.

Moreover, there are no signs yet that the phenomenal growth in spending on out-of-home meals in recent years is abating. But this is not a simple business: tastes change, trends come and go. It takes excellence more than a hot disc jockey to get it right time after time.

Furthermore, Capital is buying into one of the trendiest business sectors in town, and paying the consequent top price for the privilege. To be fair, Mr Eyre had to do something. The City was breathing down his neck, wondering, urging him on to bid or be bid for. Unfortunately, this investment isn't going to convince anyone; are those who think Capital Their Kinda Radio Station going to turn to Mr Eyre for Their Kinda Pizza? It looks Kinda doubtful.

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