Deflation effect kicks in

UK STOCKS may fall this week, taking their lead from the US, as people assess the upheaval in Asia. Investors are likely to focus on retailers' reports on Christmas sales in order to gauge the strength of consumer demand.

"The Asian contagion is spreading," said Tom Eyre, an investment manager at BWD Rensburg. "There are the first signs of profit worries."

The FT-SE 100 index fell 1.06 per cent to 5138.3 in the week, with HSBC Holdings, Standard & Chartered and Cable & Wireless leading the decline. The retail banking sub-index was the biggest loser in the FT-SE 350 index, as HSBC Holdings has lost nearly 14 per cent since the start of the year. Cable & Wireless has slumped nearly 7 per cent.

The decline came after Hong Kong's Hang Seng index fell 16.7 per cent last week. Stocks in South-east Asia fell, reflecting the slump in local currencies, pushing up interest rates and crushing businesses trying to repay dollar-denominated debts.

"There is no doubt that Asia will have an effect. Exporters are going to find it more difficult," said Peter Cogliatti, a trader at Williams de Broe. "Competition is going to be more difficult."

Some of the largest retailers, including Boots and Dixons, are set to update investors on their Christmas showing. Retail price figures and a sales monitor for December are also due to be released. "On balance, retail figures will range from satisfactory to disappointing," said Logie Cassells, a fund manager at Capel-Cure Myers. Boots is set to issue a trading statement tomorrow, with Dixons, Kingfisher and Sears and House of Fraser following later in the week.

Last week's CBI report showed that sales in British shops, stores and supermarkets rebounded in December, increasing at a faster annual rate than they grew in November. Next week's releases are expected to underpin this trend.

Gilts are set to extend recent gains, as reports provide further evidence that the economy is slowing down. This week sees reports on inflation at producer and retail price levels, industrial output, retail sales and unemployment. Minutes of the Bank of England's monthly monetary meeting in December, when rates were left on hold, will also be published.

"The data is likely to be reasonably bond-friendly," said Steve Andrew, fixed income analyst at Merrill Lynch. "We'll see modest output growth and stable inflation, and the labour market report probably won't ruffle too many feathers. With sentiment globally so bullish, it's difficult to see gilts bucking the trend."

The benchmark 7.25 per cent 10-year gilt yield fell 4 basis points to 6.01 per cent on Friday. Gilts have gained as traders and investors revised expectations on how high interest rates are headed, and how quickly they might fall later this year, supported by the prospect of lower US rates.

"Short sterling has been lifted by a perception that monetary policy in the US has shifted to an easing bias, and that UK rates will fall later this year," said Steven Mansell, fixed income strategist at BNP Global Markets Research.

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