UK BONDS are expected to be little changed and stocks mixed this week as Thursday's unexpected increase in interest rates prompts investors to reassess the outlook.
Concern that rates may rise again is likely to offset economic reports which are expected to show that the economy is beginning to slow, and renewed speculation about mergers and acquisitions in the drugs industry.
"We're likely to see some consolidation in gilts next week," said John McNeill, a market strategist at Sutherlands Stockbrokers in Edinburgh. "The data should support the view that Thursday's rate rise can be reversed before too long, but plenty of people got their fingers burned last week and they'll be in no hurry to return to the market."
For the week the benchmark 10-year gilt fell, leaving its yield about 6 basis points higher at 5.75 per cent. Key economic reports this week include producer price inflation on Monday, and a survey of retail sales, on Tuesday.
Some analysts said rates may rise again before they start to come down, with wage growth unlikely to slow enough in coming months to satisfy the central bank that inflation will fall to the Government's 2.5 per cent target rate from the 3.0 per cent annual rate recorded in April.
"We neither think that [Thursday's] rate increase will tip the economy over the edge, nor lead to a sufficient moderation in private-sector earnings growth," said Ian Amstad, director of economic research at Bankers Trust International.
SmithKline Beecham, Zeneca Group and Glaxo Welcome may all extend gains on the optimism that at least one of them will be the target of a takeover bid.
"Drug stocks tend to move in fits and starts depending on the latest takeover speculation," said Tom Eyre, a fund manager at BWD Rensburg. "The gains will probably continue."
The benchmark FT-SE 100 Index rose 1.3 per cent, to 9,947.3 last week. Railtrack gained the most.
The FT-SE Tobacco Index advanced 5.8 per cent, with BAT jumping on hopes that the United States Congress won't agree on a bill to heavily tax and regulate tobacco products.
Thursday's surprise rise in interest rates is unlikely to weigh on stocks.
"The market digested the shock rate rise very, very well," Mr Eyre said. "People are saying that the moment of rates peaking has come."
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