International Markets: London: Rate-rise fears dampen recovery from Asian flu

UK stocks may gain this week as concern eases that Asian markets are heading for another fall, or that the region's economic woes will cut corporate earnings.

Still, the prospect of interest rate rises in the UK is likely to keep a lid on any gains, while the strength of the pound hits exporters. Gilts also face a testing week with economic reports set to give further clues on whether rates will rise.

On Wednesday and Thursday the Bank of England's monetary policy committee meets to set interest rates, with the decision announced at midday on Thursday. While most analysts don't expect official rates to be raised, signs of further strength in the economy could increase concern about how high rates are headed next year.

"I don't think the Bank of England will raise rates next week," said Steven Mansell, senior fixed income strategist at BNP Global Markets Research. "But gilts are vulnerable to strong domestic numbers and signs of strength in the US economy, which could upset bonds there."

The benchmark 7.25 per cent 10-year gilt yield on Friday fell five basis points to 6.5 per cent.

Equity investors are more sanguine. "I feel quite optimistic about the UK market," said Mark Tyndall, a fund manager at Apax Partners Asset Management in Edinburgh. "I think Asia's problems are serious for the region, but they are manageable. "

The benchmark FT-SE 100 index on Friday fell 1.17 per cent to 4831.8, down 3.1 per cent on the week, mainly due to concern that Asia's woes were spreading to Japan. "World markets have shown themselves to be resilient to the Asian crisis," said Tom Eyre, an investment manager at BWD Rensburg. "Still, you don't know if this is just the calm before another storm."

The recent purchases of some UK companies by foreign investors may help bolster stocks, providing British fund managers with cash to invest. Last week, Merrill Lynch agreed to buy Mercury Asset Management Group for pounds 3.1bn, and yesterday Redland accepted a pounds 2.2bn takeover bid (including debt) by France's Lafarge.

"There is a lot of bid money coming in," which may reflect UK stocks are cheap compared with European counterparts, Eyre said. He forecast the FT-SE 100 would remain between 4800 and 5000 until the end of the year.

Concern about how high interest rates are headed was sparked by a pre- Budget statement from Chancellor Gordon Brown earlier this week, in which he raised his forecasts for inflation to 2.75 per cent for 1997 and to 3 per cent for next year.

"There were hints that there may be more rate rises," Mr Eyre said. Another 25 or 50 basis points on rates is most likely.

With UK rates set to rise, the pound is unlikely to pare any of its recent gains, maintaining the pressure on exporters and companies which make much of their income abroad.

Copyright: IOS & Bloomberg