Pound's plunge prompts shift from blue chips
Saturday 09 August 1997
On the stock market, the fall in sterling prompted a shift out of the high-flying FTSE100 index of leading companies into exporters and other second-line stocks that have missed out on the market's surge.
Sterling tumbled another 5 pfennigs to DM2.92, 14 pfennigs or almost 5 per cent down on its recent high of DM3.06 against the German currency. The fall was a continuing reaction to comments from the Bank of England, as it raised base rates for the fourth time in as many months, that the cost of money was now consistent with its inflation target.
The Bank's carefully worded statement, accompanying the rise in base rate from 6.75 to 7 per cent, was seen as a clever way of keeping the lid on consumer spending while at the same time avoiding the collateral damage to industry of a sky-high pound. Despite its success, economists said yesterday they did not expect the Bank to make a habit of talking the pound up or down.
Sterling's fall, after its dramatic 25 per cent rise since the beginning of the year, gave a shot in the arm to the FTSE250 index of medium-sized stocks, which closed 52.3 points higher at 4650.5 compared with a 55.5- point fall in the FTSE 100, which closed at 5,031.3.
The leading index was driven lower by Wall Street, which traded sharply lower as investors fretted about reports due next week on inflation and retail sales. Worries that interest rates will have to rise in the US have pushed bond yields higher, emphasising the perceived over-valuation of American shares.
The rise in London's second-liners ended a long period of underperformance that has seen the smaller stocks lag the leading index by 18 per cent since January as investors flocked to the financials and pharmaceuticals that dominate the top flight.
The mid-cap index is loaded with exporters, engineers and other companies highly exposed to foreign, especially European, markets. During the next few holiday weeks, in which few companies are expected to report results, the stock market is expected to be unusually susceptible to currency movements.
One trader said: "I expect to see more switching into 250 stocks, but remember that this is the silly season when the market is more vulnerable to erratic moves."
The markets will have to contend with a stream of economic data in the next week, with Monday's producer prices numbers followed by retail prices on Tuesday and unemployment and average earnings figures midweek. Also on Wednesday, the Bank of England will issue its quarterly Inflation Report and the minutes of last month's meeting of the Monetary Policy Committee.
Beneficiaries of the pound's fall yesterday included engineers Smiths Industries, Lucas Varity and GKN as well as building stocks such as Blue Circle and RMC, which are among the stocks most vulnerable to movements in interest rates.
The Bank of England was only given the freedom to set interest rates in May, since when it has nudged the rate upwards four times. Its advice to increase rates had been consistently ignored for months by former Conservative Chancellor Kenneth Clarke in the run-up to the general election.
According to Alison Cottrell, chief economist at Paine Webber: "The Bank of England has only now got to where it is happy, its neutral starting point with interest rates."
She added: "They moved in slow steps, but this built the expectation that they would do another small step every time. They've said, `In case you are worried, we think we've got to where we want to be now'. It's quite comforting, because it implies that had they thought they needed a half-point increase, they would have done it.".
Despite the hint from the Bank that it would hold off for a few months before raising rates again, most economists still expect base rates to rise again with some believing the peak in the current cycle could be as high as 8.5 per cent.
The Bank did not receive universal praise for its intervention. Richard Jeffrey, group economist at Charterhouse, said: "I think there is a great danger that when policymakers get involved in currency markets they tend to come off worst. The currency has to be allowed to find its own level."
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