International Markets: Investors wary on eve of anniversary

LONDON
UK markets are likely to be pulled two ways as investors debate the outlook for interest rates. Stocks are expected to slip as investors nervously register the approach of the tenth anniversary of the 1987 stock market crash at the end of the week.

By contrast, bonds are expected to gain as producer price figures show inflation is not accelerating, dampening concerns about how big any further rate increases will be.

"In relative terms, the gilt market still has a lot going for it," said Tony Turner, a fund manager at Norwich Union Investment Management. "The economy isn't running out of control."

Last week, the benchmark 7.25 per cent government bond was little changed on the week with the yield at 6.5 per cent, up 31 basis points. However the FT-SE 100 Index fell to 5,227.3, down 103 points, or 1.9 per cent. Banks, including HSBC Holdings, oil and drug companies led the decline.

In 1987, the FT-SE index lost 12 per cent in two days.

"There are a lot of parallels between 1987 and 1997," said Job Curtis, a director at Henderson Investors. "The market consensus has been that inflation isn't a problem but if we get some more strong numbers, these expectations could shift."

Figures are due out this week on producer prices, employment, and on the public sector borrowing requirement. The Bank of England will also release minutes from its last rate meeting.

Economists expect producer prices tomorrow will show factory gate prices grew at an annual pace of 1.3 per cent in September, down from 1.4 per cent in August, posing no threat of inflation.

"It is pretty clear that price pressures at the factory gate remain subdued," said Philip Shaw, an economist at Investec. "We expect no significant change before the end of the year."

Still, investors expect the central bank to raise the base lending rate by a quarter percentage point to 7.25 per cent by the end of the year to keep inflation in control.

"We're still expecting a couple of quarter-point rises over the next six months, with probably one more rise this year," Mr Turner at Norwich Union said.

Gilts have benefited as investors bail out of European bonds. Higher interest rates in several countries, as well as the resignation of Italian Prime Minister Romano Prodi, after he failed to get his coalition partners to agree a budget compromise, have helped make gilts look more attractive.

Bonds across Europe were hurt on Thursday after the Bundesbank raised its target money market rate for the first time in five years.

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