London market: Gilts to revive on hopes of interest cut

GILTS may rally this week on hopes that slowing inflation, pushed down by a strong pound, will resolve the Bank of England's split vote on monetary policy in favour of reducing interest rates.

"We could see another 25 basis points off rates in June," said Dick Howard at Julius Baer Investments. But, given the closeness of the Bank's most recent vote on rates, "they may be happy to sit on their hands a little longer," waiting for further clues on the strength of the economic recovery.

The benchmark 10-year bond yield fell three basis points to 4.78 per cent last week.

Disappointing earnings are likely to drag down shares of British Airways and EMI Group, both of which have suffered from slow sales. Most stocks are expected to yo-yo as investors decide whether interest rates have further to fall.

BA is expected to post lower earnings as a result of fare wars on North Atlantic routes. EMI, which makes 18 per cent of its sales in the Asia- Pacific region, is also in line for lower earnings. "These are two companies operating in very difficult industries where they aren't up to the conditions," said Eric Moore, manager at Gartmore Capital Management.

The FT-SE 100 index rose 0.8 per cent last week, to 6,353.1. Gains were led by BT, which surged 10.3 per cent after it said on Wednesday that fourth-quarter profit rose by 36 per cent.

Mixed signals on the economy are making it tough to predict whether the Bank will cut rates again. Figures showing that a greater-than-expected fall in retail sales were offset by stronger-than-expected money supply and rises in bank lending. "Data suggests that rates have troughed, but sterling remains a threat to this view," said Mark Wall at Deutsche Bank.

Other economists see rates going lower in coming months, though climbing swiftly thereafter as the economy recovers.

"I think we will see one more rate cut in the summer," said Kevin Gardiner, economist with Morgan Stanley. "Then rates could rebound quite sharply next year."

There are few important economic reports this week to settle the rates outlook. The most important will be the CBI industrial trends survey for May.

Investors remain undecided, switching between companies whose earnings rely on an expanding economy and those whose earnings are protected from weaker growth.