In the City
Market worries
Nicholas Davenport
I have only to be away from the City for two weeks — writing, you may have observed, a blue-print for a social revolution in our capitalist system — to find the Bank of England losing its poise again and going all out for another monetary overkill. In the last financial year it issued over £9,000 million of 'tap' stocks in the gilt-edged market. This was far more than was necessary to keep the money supply within supposed IMF targets. Allowing for redemptions of maturing stocks the overkill was probably £1,000 million. Having regard to the fact that there are still £780 million calls to be made on the partly paid stocks issued — 57 per cent on £800 million of Exchequer %per cent 1982 on 4 July and 41 per cent on £800 million of Exchequer 12* per cent on 13 June — the market had assumed that there would not be any more 'tap' issues for some considerable time, especially as the Bank had just issued its new hybrid —£400 million of variable rate Treasury stock. So the announcement last week of a further £800 million of Treasury 11 per cent 1991 — at 94 to yield 12i per cent flat and 12.69 per cent to redemption and with only 15 per cent payable on application — was a surprise and shock to a market which had been falling sharply over the past two weeks. No one had expected the mild Governor of the Bank to hit a man who was down.
The absurd situation is now presented of a Bank rate of 8 per cent and a Treasury bill rate of 7.43 per cent while yields can be obtained of over 10i per cent on 'shorts' and 13i per cent on long-dated British government stocks. Is the Governor trying to say that Bank rate is too low now that our inflation rate has risen and the Federal Reserve has raised its discount rate in an attempt to bring down the American rate of inflation? It looks as if he is wanting to see dearer money, especially as he has to support sterling out of the reserves last month. He has already allowed the coupons on local authority 'yearlings' to rise from 91/s to 9i per cent. This is a bad sign. Dearer money puts up the running costs of all the local authorities and is an inflationary force. If dearer money spreads to the business world it will check our business recovery, which is slow enough in all conscience.
The National Institute of Economic and Social Research in its latest Bulletin gives a possible explanation of the Bank's surprising new 'tap'. It says that as interest rates will probably stop falling in the near future — Bank rate has come down from 15 to 8 per cent since last October — this is likely to pose difficulties for the funding of the PSBR (public sector borrowing requitement) in the current financial year. The Institute thinks that a rise in interest rates later on may be necessary if the money supply is to be kept under control in 197879. I don't agree. On their own assumptions, and given their balance of payments projection of a surplus of oyer £400 million this year and £1200 million in 1978, the DCE (domestic credit expansion) should be only £7,00 million in 1977-78 and £6,000 million in 1978-79, which is within the IMF targets for these two financial years.
The growth of the money supply is, of course, impossible to predict because of the uncertainty of the private sector demand for bank advances. In my view M3 is not likely to show any significant increase and in fact, the Institute estimates a rise of only 7.9 per cent in 1977. Money supply is running at the moment well below the credit availability at the banks. In view of the Bank's overkill in 'tap' issues, which has already taken place, there is no need to worry about the possibility of any dangerous increase in the money supply. So let Bank rates remain at 8 per cent.
As regards the all-important Stage 3 pay negotiations, the Institute is assuming an annual rate of increase in average earnings (not pay rates) of 15 per cent which seems to be a reasonable guess about what might happen. As this rate of increase in earnings is higher than the one realised under Stage 2 it is possible that the inflation rate will not fall much further. Indeed, if the pay agree ment breaks down, says the Institute, and the average rate of increase in earnings rises to 20 per cent by the spring of 1978 and to 25 per cent by the autumn, then the economy would be presented with the sort of crisis experienced in 1974-75 with infla tion rising rapidly and unemployment approaching two million. The oil surplus on the balance of payments would therefore bring no hope of ever getting the British economy right. The Stage 3 pay negotiations therefore remain, in the Institute's opinion, crucial, which is what every one knows and fears.
Equity shares have naturally been upset by the shocks in the gilt-edged market, by the foolish threat of dear money and by the uncertainties of the pay negotiations. The bullishness which had carried the FT index up to 477 — on mere rumour, I should add, that dividend limitation was about to be removed — has certainly disappeared, but the fall to 448 at the beginning of the month is not, in my view, to be regarded as anything worse than a seasonal correction.
It must be remembered that the equity market had risen 80 per cent between the end of October and the middle of May — from 265 to 477 — which is actually sharper than the rise in the whole of the bull market under Mr Heath. The rise in the Heathian market from March 1971 (305) to 19 May 1972 (543) was only 78 per cent. After such a sharp rise it was to be expected that the market would fall back and seek a firm foundation for the next burst of strength.
But this cannot take place until the pro
jected sale of the BP shares held by the Bank of England has been disclosed and digested. It is a huge morsel for the market to swallow — of the order of £600 million. Even if the Government decides to make an issue of Treasury stock which is con" vertible into BP shares on certain terms and dates, as some people have suggested, it is still a huge issue for the institutions to swal low, especially as the Bank has been spoiling their appetite with unnecessary 'tap' issues. So for some months the equity mar ket may remain nervous until this oil blowout is 'tapped. It would be amusing if Tony Benn the 'Texan', who opposes this sale of BP, (as well as the EEC) were to resign from the Government, as Paul Johnson urges him to do, and comes to the rescue of the equity market by getting a Marxist-mad Labour Party to squash the deal.
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