View from City Road: Funding sums need to add up

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The Independent Online
THE gloomier the noises from the Confederation of British Industry and the louder the wailings from Britain's builders the more convinced the stock market becomes that short-term interest rates will continue to fall.

Share prices tend to look 12 months ahead. Thus they anticipate the upturn in activity that investors reckon must follow an easing in monetary policy.

So dire is the state of opinion on the UK economy that markets seem impatient to see this easing continue or gather pace.

Diverting rumours that Norman Lamont would announce an instant 2 per cent cut in interest rates in his Mansion House speech tomorrow night were quickly squashed by officials yesterday.

But this and a near 1-point drop at one stage in what is in effect sterling's index could not prevent a modest 8.2 point advance to 2,669.8 by the FT-SE 100. Help was provided by a better-than-expected third- quarter US GDP of 2.7 per cent and marginally encouraging comments on German interest rates out of the Bundesbank.

But there is still one large and as yet unanswered question that the markets will want some guidance on from Mr Lamont at tomorrow night's banquet. There appears to be a competition to forecast the largest public sector borrowing requirement. UBS Phillips & Drew leads with a staggering pounds 57bn for 1993/4.

The rival James Capel expects institutional cash flows to total only pounds 32m in that financial year. How will the gap be plugged? UK institutions are unlikely to want to run down their stocks of cash or UK and overseas equities. Foreign investors, traumatised by sterling's undignified self-ejection from the ERM, can hardly be relied on.

UK long bonds yield less than 1 per cent more than German bonds. Historically they have yielded 3 or 4 per cent more, so the risk premium is currently small.

This all points to pressure on longer-term bond yields which, although having a depressing effect on real investment, could increase the attractions of equities at the expense, initially, of gilts.

This pressure will be less if the Chancellor opts for underfunding - selling fewer gilts than are needed to mop up cash created by the PSBR - which is the City's hot tip for tomorrow night despite official signs that there will be no novelties.

Until the sums look like adding up the natural urge of share prices to rise may not be given full play.