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Brian Tora: Gilt yields suggest base rates rise sooner than expected

Yields on 10 year gilts and US treasury are back above 3 per cent for the first time since 2007 and give a strong indication that central banks will begin to increase base rates sooner than expected.

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Uncertainty over how developments in Syria might pan out continued to weigh on market sentiment last week although news elsewhere was generally more encouraging.

Economically, our global business village appears to be making slow but steady progress although India has continued to cause concern. Last week saw Goldman Sachs lower its expectations for India’s GDP growth this year to 4 per cent, while the Rupee hit new lows against the dollar.

In contrast, sterling seems to be taking encouragement from the new Bank of England governor. His apparent stance on interest rates at first pushed the pound lower, but his determination to restore the strength of the banking system is helping rebuild confidence and attract buyers for our currency. Moreover, there seems growing confidence that his unemployment target might be met sooner than expected, allowing interest rates to rise.

In some regard it is surprising that our benchmark FTSE 100 Share index is not making more progress although the influence of mining shares on its performance will not have helped matters. Perhaps we can get more of a steer by looking at other markets. The FTSE 250, much more of a domestically focussed market, has been doing rather better than its large cap stable mate. But fixed interest markets are even more interesting.

Last week saw a momentous landmark in government bond markets reached, with ten year yields breaking back above 3 per cent in both the US and here in the UK for the first time since 2011. They have been trending steadily higher ever since Ben Bernanke first indicated that quantitative easing may be coming to an end, but a steady stream of more encouraging economic data is building momentum on both sides of the Atlantic.

What this is telling us, of course, is that interest rates will be going up in the not too distant future. Some futures markets are already factoring in base rates here of over 2 per cent, perhaps as soon as 2015. Yet banks are still cutting back on how much they pay savers, while annuity rates remain depressingly low.

While I consider it hardly likely that Mr Carney will act precipitately – he can allow the market to do much of his work for him – by next year the writing will surely be on the wall for dearer money.

Higher interest rates will benefit huge swathes of the community, with savers now having been starved of decent returns for several years. But the risk is that the squeeze on borrowers will intensify before economic growth starts to reward consumers. This could lead to wage demands of inflation plus, something that has been remarkably absent for some time. The indicator to watch will be the incidence of worker unrest – in other words, more strikes.

It could be that next year turns out to be an interesting one for investors, with opportunities and threats abounding. More evidence of a sustainable economic recovery could lead to more activity in mergers and acquisitions, not that we are particularly short of excitement in this arena at present. Last week saw two massive corporate deals in mobile telephony involving some of the biggest names in technology and telecoms.

If the slide in government bond markets continues, we could see a return of the reverse yield gap, when equities yield less than bonds, suggesting an appetite for risk has returned.

Better economic progress could lead to more generous wage settlements, stoking a consumer recovery which remains tentative in the current climate. None of this need be negative for shares, but the winners and losers are hard to identify at this early stage. And we do need to watch out for strikes, not to mention unrest in the Middle East. Roll on next year.

Brian Tora is an associate with investment managers JM Finn & Co

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