View from City Road: Grudging reaction to good news on inflation

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The Independent Online
Time was when the gilt market and shares would have soared on news that underlying inflation had dipped into the lower half of the Government's target range, achieving a long-cherished objective. Not so yesterday, when the Government announced that inflation in March dropped to 2.4 per cent, edging into the 1-2.5 per cent range.

True enough, gilts and shares did rally - the FT-SE 100-share index rose 36.6 to 3,168 - and the short sterling contract, which has been pointing to a rise in base rates, reversed its stance to indicate an unchanged rate of 5.25 per cent.

Given that the Bundesbank had only the day before trimmed rates, this was a pretty grudging reaction. The markets liked the good news but not enough to stop them worrying that the best may be over by summer.

At Nomura Research, Nick Knight continues to advise his clients to sell into strength. The market, he insists, is heading towards 2,800 and interest rates back up to 6 per cent or worse by the end of the year.

It is still possible the Chancellor could sneak through a final cut in rates, but he would need a run of good inflation figures, coupled with convincing evidence (unavailable so far) that tax increases are causing the recovery to buckle, to get away with it.

Much more likely is that rates will be left unchanged before the next inevitable move upwards. Base rates have already fallen from 15 per cent since October 1990 - a powerful stimulus which acts with very long lags. A quarter point more will make little difference to the endurance of recovery.

What does all this mean for the stock market? Markets took the view a long time ago that Britain is at a turning point in the interest rate cycle. Some strategists, notably Salomon Brothers, continue to insist that it is not - that the economy is not yet advanced enough for that to happen - but they are increasingly lone voices.

A full-blown crash seems unlikely, but the outlook for both shares and bonds for the remainder of this year looks distinctly unexciting.