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Rate worries set to plague shares

UK stocks are expected to slip this week as the spectre of higher interest rates raises worries about rising borrowing costs and falling profits.

National Westminster will be in the spotlight first thing tomorrow after it announced late on Friday that it had discovered "mispricing errors" at its investment banking arm that will require a pounds 50m charge.

Investors are unlikely to make significant changes to portfolios until they have analysed earnings reports from some of the country's biggest companies, including HSBC, BAT, General Accident, Glaxo Wellcome, Cadbury Schweppes, Royal & Sun Alliance and GKN.

Concern that Wall Street will extend last week's disappointing performance will also encourage investors to move cautiously, if at all.

Much of the blame for the unease lies with US Federal Reserve chairman Alan Greenspan, who suggested last week that the Fed might raise interest rates. But concern also stems from renewed doubts about the single currency starting on time, which is likely to spur German mark buying and could pull down other European currencies, including the pound. That could give the Bank of England leeway to raise rates without battering already beleaguered manufacturers and exporters.

Higher rates increase the cost of borrowing money, slowing corporate growth and making fixed income investments, such as bonds, relatively more attractive than equities.

Lower bond prices - the 10-year gilt tumbled 18/32 on Friday, wiping more than 70 pence off the value of a pounds 100 bond - could add to the market's woes, weighing on the shares of financial companies, which typically have large bond portfolios.

But not everyone is sure the UK market is set to fall, even if the Fed and the Bank of England begin to raise rates.

"We are in a benign inflation environment that is very healthy for the equity markets," said Mark Thompson, a fund manager at AXA Equity & Law Investment Management. "Central banks are getting better at reading the economy and we will see them slowing the economy, which is better than slamming on the brakes."

Last week the FT-SE 100 slipped 0.66 per cent, with bond market setbacks weighing on financial shares.

Much will depend on what happens in the US. Wall Street is expected to be volatile: few earnings and economic reports are scheduled, giving investors little guidance - and lots of time to think about Mr Greenspan's warning.

The Dow Jones Industrial Average slipped 0.78 per cent last week amid concern that rising rates will cut into profits. The 30-stock average was little changed for February, rising 68 points or 0.93 per cent, compared with a 5.7 per cent gain in January.

In Tokyo, auto and electronics shares may extend last week's steep losses if the dollar falls below Y119, eroding the value of overseas earnings. But bank stocks could get a boost if proposals to help the industry deal with trillions of yen in bad loans make progress. Last week the Nikkei 225 stock average sank 2.51 per cent.

In Paris and Frankfurt the dollar's strength against the mark will be a key factor in determining whether indexes extend last week's gains. Earnings reports from several key French companies will also determine the direction of trading in Paris.

Last week, Paris's CAC index rose 1.74 per cent. Several economic reports showing accelerating economic growth also boosted shares.

In Frankfurt, the benchmark DAX index rose 2 per cent last week, pulled higher by gains by Volkswagen, Schering and Henkel shares. Copyright: IOS & Bloomberg.