Leadership crisis frays nerves

Tumbling gilt and future prices dragged shares down in London yesterday as poor economic figures from Germany compounded nervousness over the Tory leadership crisis.

As concerns mount about a deteriorating UK inflation outlook, the City is praying above all else for a clear-cut resolution to John Major's challenge to his rivals "to put up or shut up".

Howard Carter, chief economist with Friends Provident, said: "The worst outcome for the markets is a messy solution - if Major wins the first ballot but the total of votes against and abstentions is 100 or so, yet he carries on regardless."

The deepest gloom was reflected in ultra-long gilts, which dropped two points. The September long-gilt future was down over a point at just over 105. The domestic political nervousness was exacerbated by unexpectedly disappointing inflation figures from Germany, which dashed hopes of an early Bundesbank cut in interest rates.

Market sentiment was further dented by worries that the current climate of political turbulence would frighten foreign investors off next week's auction of pounds 2.5bn of 10-year stock. There are also strong expectations of an upward revision of the 199596 public sector borrowing requirement in the Treasury's summer forecast on Wednesday.

Sterling remained relatively unaffected by the turbulence. It was off a cent from Thursday's London close at $1.5982, and was up half a pfennig at DM2.2294.

Shares looked as though they would hold their nerve at the start of the day, but as news of the resignation of Douglas Hurd, the Foreign Secretary, was announced, prices slid quickly. The FT-SE 100 shed 24.4 points to close at 3,379.4.

Among City economists, the initial shock of Mr Major's surprise challenge to the rebels within his party gave way quickly to broader worries about what the Tories may try to do, whatever the leadership outcome, to restore their fortunes.

Michael Saunders, of Salomon Brothers, said: "This defiance by Major has highlighted the fact that the approach of the election is finally focusing Conservative MPs' minds on how they can win. The suspicion is that whoever wins it will not be enough for a sustained boost to their fortunes, and so the give-away pressures will be strong."

Another economist warned the currency stability might not last long if worries increased that the Tories, with a new or old leader, gave in to the temptations of a dash for feel-good stimulus.

Betting in the City yesterday was that Michael Heseltine, President of the Board of Trade, was the man most likely to beat Mr Major, notwithstanding all his current protestations of loyalty to the Prime Minister.

Mark Reckless, UK eonomist at SG Warburg, said: "Whatever happens in this leadership contest it is not going to resolve the problems in the eyes of the market. The European issue will not disappear, the Tories will not have a bigger majority. The focus will still be on what the Tories are going to do to hold on to as many seats as possible with tax cuts and base rates.

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