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.
