London shares rebound from early slump: Bargain-hunting saves the day after an attack of interest rate gloom

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The Independent Online
BARGAIN-HUNTERS came to the rescue in stock markets and government bond markets yesterday after a surprise leap in German money supply growth triggered sharp falls in prices by adding to gloom on interest rates.

The FT-SE index of 100 leading London shares closed 22.5 points lower at 3,248.1, having been 75 points down earlier in the day. The gilts market also recovered some lost ground after sharp falls.

'Equity and bond markets are being driven by fear and the desire to preserve capital,' said George Magnus, of Warburg Securities. He warned that the markets had all the trappings of a big financial accident, with investors reacting badly to new issues of government debt.

Yesterday's sell-off was triggered by figures showing that growth in the broad measure of German money supply M3 - to which the Bundesbank traditionally points as the best indicator of future inflation - accelerated well ahead of expectations in January.

M3 rose at an annualised 20.6 per cent between the last three months of 1993 and January, well above the Bundesbank's 6 per cent ceiling for the year. But M3 was boosted in December by special factors, which ensured that a further modest rise in January led to a sharp acceleration in the annual rate.

The factors boosting M3 in December included the extension of withholding tax to the interest earned on investments abroad made by German banks for their German customers.

This made investment abroad less tax-advantageous, triggering repatriation of funds from Luxembourg. The reduction of tax breaks on housebuilding at the turn of the year also boosted bank lending to beat the deadline.

Chris Dillow, economist at Nomura, said the Bundesbank had been excusing high M3 growth with special factors for three years and this was damaging its credibility with the markets.

But Stephen King, of James Capel, said that lower inflation was still likely to be the dominant feature for the Bundesbank over coming months, and the key discount interest rate was likely to reach 3 per cent early next year.

The German government bond market rallied strongly during the afternoon on hopes that the Bundesbank might cut its key 'repo' interest rate today in a bid to calm the markets. But some analysts said this could be seized on as a sign of panic, while Alison Cottrell, of Midland Global Markets, noted that it would do the German bond market little good by damaging the Bundesbank's domestic credibility.

The market turmoil cast a shadow over yesterday's monthly meeting between Kenneth Clarke, the Chancellor, and Eddie George, Governor of the Bank of England.

The markets have priced in another quarter-point cut in bank base rates from 5.25 to 5 per cent, but most analysts do not expect it until April's tax rises are hitting home and the European and local elections are closer.