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Investment View

Sir Edward might have to write that letter, now that inflation is down to 1.8 per cent. If the monetary policy committee undershoots the Government&#39s target by more than 1 per cent, then the governor has to explain why. In case you wonder why some inflation is considered desirable, then cast your eye across to Japan where deflation has undermined consumer and business confidence.

The significance of low inflation – in the short-term, at any rate – is that it makes further rate cuts more likely. Following last month&#39s US interest rate reduction, we are now the proud possessors of the most expensive money among the world&#39s developed countries. The Fed Funds rate is 5.5 per cent compared with our own 5.75 per cent while eurozone interest rates are a full 1 per cent lower. The market here is factoring in further cuts and there seems little reason to believe the disparity between ourselves and Europe will remain this wide. If Europe starts to cut rates it is unlikely to be by much, given the robust statistics from the Continent.

Figures from Italy and the Netherlands suggest economic growth at the end of 2000 was around 3 per cent. This may be a pale shadow of America – and much less than Ireland – but it hardly represents a recession. But a useful bounce by the euro against the dollar has run out of steam. It may be because fears of a full-blown US recession are receding. Unfortunately, eurozone central bankers were beginning to become used to the idea of dollar/euro parity.

History shows falling interest rates are good for equity markets, yet there is no sign of the UK market anticipating cheaper money. Perhaps it is because much of the interpretation of the data available is contradictory. One research note I read last week suggested that both America and the UK would flirt with recession while another pointed to the unacceptably high level of monetary growth, particularly in America, as a factor likely to restimulate inflation.

In my view, America is unlikely to have a full-blown recession, with the real pain being caused partly by the speed of the slowdown in the US economy, but also because of the significant and rapidly developing problems in the new economy. Investors had not factored in that technology companies had done so well previously because of the accelerated level of expenditure in 1999. They are now seeing the effects of falling demand because there is no need to upgrade software or equipment that has proved to be robust in the wake of the millennium bug along with the realisation that spending on technology is as economically sensitive as any other area of expenditure in business. Telecoms, of course, has its own problems.

If correct, this interpretation of what has happened in markets suggests better conditions should return later this year in some areas of the economy. In the meantime, an area that seems to have been overlooked is that of zero dividend preference shares, where considerable value is available. In part, this is a reflection of concerns that a real bear market may yet undermine the trusts&#39 ability to re-pay preference issues. As the management houses that specialise in split-level trusts are only too keen to tell you, no preference share has yet failed to be repaid while the hurdle rates of most issues demonstrates that portfolios actually need to decline in value on a regular basis for full redemption not to take place.

Whenever I meet with investment IFAs, they all seem to have bought into the concept so I wonder why the yield premium that zeros demand over conventional bonds remains as high as it is? Perhaps people really are sitting on cash, just waiting for the opportunity to tip it into the equity market. What a comforting thought.


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