In part, that is explained by the fact that the Fed's tightening has prepared global markets so thoroughly for others to follow that there is scarcely anything left to react to. Indeed, the paradoxical effect of yesterday's rise in short-term rates is to cause long-term rates (the yield on long-dated gilts) to fall, on the premise that early pre-emptive action by the Chancellor will ease inflationary pressures later, improving the attractions of long-dated bonds.
For the time being at least, the Chancellor seems to be heeding the imperatives of the market, not the hysterical calls of his vote-starved back-benchers. His now famous summer pledge to abolish the boom-to- bust cycle must perhaps be taken seriously after all. The politics of the move is for others to comment on. Certainly it is not the Kamikaze move it might at first appear. If the effect is to provide sustained growth in a low- inflation environment the Chancellor can reasonably assume that by the time of the next election, the positive aspects of such a policy might be better appreciated by the voter. High growth against a backdrop of rip-roaring inflation would presumably not.
Though the timing of the move burnt a few fingers in the money markets, it is hard to quarrel with the Government's decision to give a tough and pre-emptive signal. Most investors have rightly been sceptical of claims that the new phase of growth on which the economy has embarked will be different from past booms and busts.
There is an election not too far away, growth is reviving in the rest of Europe and Japan after an impressive burst of activity in the US, the commodity price cycle is moving sharply upwards, and there are signs of bottlenecks in industries such as construction and housebuilding. In the past, all these have served as useful early warnings of inflation. If growth really is going to be steadier and more durable this time round, it requires a signal of political determination. A rise in interest rates combined with the Chancellor's pledge to resist pressure for tax cuts in the next Budget was what the City was looking for.
In the equity market, the rate rise will put a damper on growth and profit forecasts for next year. But there are two reasons not to become too gloomy about that. The obvious one is that the rate rise had generally been built into forecasts of earnings. A month or two either way hardly matters. It was hard to find equity strategists who share Nomura's gloom about the impact on companies. The stronger long-term argument for equities is very similar to the one that pushed up bond prices. The prospect of slightly slower growth lasting for three or four years, rather than two years of boom followed by a bust, ought to be good for investors.
The record also confirms that interest rate rises are not necessarily bad for investors. As George Hodgson, of SG Warburg points out, the equity market did quite well after three of the last four turning points in interest rates.
Several threatened sectors stand out from the crowd already: building and construction stocks are under pressure; property is also going to suffer from the change of direction, as are stores, though interest rates still under 6 per cent are hardly a crisis for a market that has recently experienced 15 per cent. On the whole, however, the conclusion should be that, forewarned by the long debate this year over inflation and growth, the equity market is well placed to cope with rising interest rates over the next year or so. The Government's early move on base rates makes the risks of the process spiralling out of control far less likely than last time.Reuse content