Be alert to macro-economic events that will affect the stock market. The key issue is inflation, which may be broadly defined as the continued rise in price levels that diminishes the value of money.

The Chancellor of the Exchequer, acting for the Treasury, sets the annual target for inflation, currently 2 per cent a year, as measured by the Consumer Price Index. The Bank of England has the task of keeping it to that level and, with this in mind, it has established a Monetary Policy Committee (MPC) to decide whether to change the repo rate. This is the short-term rate at which the Bank lends to banks for repurchase agreements. It is for practical purposes synonymous with base rate.

If the Bank of England announces that it will be cutting interest rates, this stimulates the stock market as well as the broad economy. It means cheaper borrowings for quoted companies, and many people will buy shares rather than leave their money on deposit for a lower return. If the Bank of England raises interest rates, it is, broadly speaking, to curb inflation and this will adversely affect shares.

If the stock market is surprised by an interest rate move, it will overreact. More often than not, it will have expected the move and will have discounted it in advance. In this case, it will react not strongly, if at all. Generally, the Bank of England tries to signal future rate changes. The MPC will have made its decisions using inflationary indicators. Here are some of the key ones:

Consumer Price Index (CPI). This is the measure used by the UK govern¬ment since December 2003 to set its annual inflation target. Gross Domestic Product (GDP). This measures national income and is revised quarterly. If GDP rises over 3 per cent in each of four quarters in succession, it sends a strong inflationary warning and the Bank of England will probably raise interest rates.

Index of Production. This monthly time series measures the volume of production in manufacturing, mining and quarrying, and energy supply industries.

Money supply. Monetarists, unlike Keynsians, believe that the money supply is the key to controlling inflation. Their views are currently out of fashion. UK money supply measures include M0, which represents narrow money - money in circulation plus sight deposits (current accounts with money available on demand), and M2, which is broad money - M0 plus savings deposits and time deposits.

Monthly unemployment count. If unemployment is falling, it benefits com¬panies that rely on consumer spending. But it may lead to a rise in interest rates to combat rising inflation fears.

Producer prices. The Producer Price Index (PPI) measures price changes in goods bought and sold by UK manufacturers. It is based on a weighted basket of goods.

Purchasing Managers’ Index. This seasonally adjusted index, known as PMI, provides a view of the manufacturing economy. Retail Price Index. The Retail Prices Index measures the price rises in a basket of goods, based on prices collected locally and centrally, with a random sampling of locations. The headline RPI has derivations, one of which is the RPI-X, which is the headline figure excluding mortgage rates. The RPI and its derivations are used for the indexation of pensions, state benefits and index-linked gilts.

The state of sterling. If sterling is strong, imported commodities, on which the UK relies heavily, are cheaper. This helps to keep inflation down.