View from City Road: Back to the beginning on ERM

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The Independent Online
AFTER celebrating three weeks of freedom from the exchange rate mechanism the stock market must surely conclude, after the Chancellor's letter to the Treasury Select Committee, that the UK is back in the ERM in all but name but at 15 per cent below its former central rate against the German mark.

Market hopes of a theatrical 0.5 point cut in interest rates were dashed even before the Chancellor began his address to the Conservative Party conference as details of the Government's post-ERM policies hit dealers' screens at noon. Hardly surprisingly, despite all the prior verbiage about a 'British' monetary policy, the new policies will not be very different from those pursued within the ERM, but without the added shackle of an exchange rate target.

The clear message for the equity markets is that there will be no rapid reduction of UK interest rates to reflate the economy. Any significant rate reductions will depend on Germany, where there are hopes that some easing may possibly be on the cards, which is more or less where we were before.

An attempt to achieve a target of an inflation rate of 2 per cent or less within five years will be made by tough controls on public spending. From this the stock market can only deduce that the consumer will have little to contribute to any near-term economic recovery. Neither will the already hard-pressed construction sector.

The burden of recovery must lie with the UK's hardly less beleaguered manufacturers, which will have to make the most they can from the recent devaluation. No wonder the currency markets and gilts, which ended 7 8 of a point higher on average, were encouraged by what the Chancellor had to say.

The stock market's early enthusiasm was dented and, despite some half-hearted buying, it ended below its best levels. You could make a case for saying that the 7 per cent increase in the stock market since the drama of three weeks ago captures the benefits of sterling's subsequent devaluation. In most other respects we are back where we were.

To see this requires only a quick look at the popular sectors yesterday. Up went health and household, conglomerates, food retailers and utilities, all a good bet as overseas earners or defensive domestic stocks, just as they were before we quit the ERM. If the Chancellor has little City credibility, a more pro-active Bank of England will help to keep policy on the deflationary rails. Cash regains strong attractions.

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