Pound slides as Americans unload gilts: CBI says recovery will survive tax rises

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THE POUND lurched to a 12-week low and US investors scrambled to unload gilts yesterday, as the markets digested Tuesday's interest rate cut and the Government appeared increasingly unsettled by the Milligan affair.

The pound dropped sharply during the morning, before stabilising in the afternoon. It closed more than 2.5 pfennigs lower at DM2.5707 and more than a cent lower at dollars 1.4610. Against a basket of currencies, sterling closed 0.7 points lower at 80.8 per cent of its 1985 value. This was the biggest one-day drop since mid-September.

However, the markets were little affected by the Confederation of British Industry's latest regional trends survey, which showed for the first time since the recovery got under way that orders for manufacturers had risen in the past four months in every region of mainland Britain.

Howard Davies, CBI director- general, tried to dispel fears of a halt to growth, claiming that 'those who argue that tax increases will stop the recovery are making a political, not an economic point'.

Steve Barrow, at Chemical Bank, said the pound's rise in recent weeks had looked overdone on technical grounds, and that Tuesday's rate cut had provided an excuse for a correction. He said the contrast between the tightening by the Federal Reserve last week and the British rate cut reinforced lingering market doubts that Kenneth Clarke might not be willing to raise interest rates when it became necessary.

Mr Barrow said that the pound could fall to between Dm2.53 and Dm2.55 in coming weeks, but in the longer term was heading to between Dm2.65 and Dm2.70.

Gilts continued to feel the pressure from US selling following the Fed's rate rise. The fear that rising US interest rates will cut the dollar value of European-based investments is removing the attraction of the higher yields available on this side of the Atlantic.

The March long gilt contract closed pounds 11 32 lower at pounds 11529 32 after a second day of heavy trading on the futures market. It had fallen to a low of pounds 1151 32 before being helped in the afternoon by a stronger performance from German and US government bonds.

Nick Parsons, of Canadian Imperial Bank of Commerce, said the aggressive selling of sterling securities had been reflected in the currency. 'International investors think this government is doomed and have taken fright,' he said.

Most analysts took the Bank and the Treasury at their word that the rate cut was not timed for political purposes, but several found the economic case less than convincing. Robert Thomas, of NatWest Markets, said the move suggested that the authorities were uncertain about the state of the recovery but that they were clearly happy with the pound lower rather than higher.

(Photograph omitted)

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