View from City Road: Drama has gone out of rate movements

Hopes rise, hopes fade, hopes rise again; and so it goes on with monotonous regularity, a case of another day, another change in sentiment over interest rates. No sooner have hopes of an early cut in base rates been boosted by good retail and producer-price inflation figures than along comes an unexpected acceleration in average earnings growth and a sharp fall in unemployment to dash them again. Traders who today say there is every chance of Kenneth Clarke, the Chancellor, going the extra quarter, will be telling you the opposite tomorrow.

It is hardly surprising that the markets appear to be tiring of the interest rate story. As we all know, interest rates have been the driving force for both equity and bond markets for at least the past year and a half.

In the aftermath of the exchange rate mechanism's collapse equity and bond markets soared as interest rates plunged. By the same token, markets have been in a state of bearish turmoil ever since last February when the Federal Reserve signalled an end to the virtuous cycle of falling interest rates.

Perhaps Mr Clarke, despite all the Fed does to stop him, will be able to go the final quarter. For the markets, however, it's become something of an irrelevance. It seems as plain as a pikestaff that whatever he does with interest rates in the short term, they will be on the rise again by the end of the year. Certainly that's what the stock market has come to believe. So whatever happens to base rates over the next month or two, do not expect markets to react with theatrical drama. The action so far has already bludgeoned them into a state of bored stupor.

At Morgan Stanley, David Roche, chief London equity strategist, believes the next bout of volatility will have nothing to do with interest rates; it's much more likely to be caused by a world event, or a political crisis. It's hard to disagree. The outlook for equities over the remainder of this year is deeply unexciting; at best shares look destined to end the year no higher than they are now.

For longer term investors, there is also a sobering message from PDFM, the UK fund management arm of Union Bank of Switzerland.

It suggests that equities everywhere are in overrated territory and UK pension funds, with 80 per cent of their assets in shares compared with 50 per cent in the US and 10 per cent in Switzerland, are taking excessive risks with such a high exposure. Savers everywhere, beware.