Separating signals from noise

ECONOMIC VIEW

The background noise has become so loud that it has become very difficult to pick up the signals. There is too much information - political, economic, financial - of too low a quality. The result is the sort of confused, twitchy, irrational market movements that manifested themselves yesterday. Most commentators respond to this by saying that markets dislike uncertainty, but actually there is as much truth in the reverse: many market players actually like uncertainty because it enables anyone who has a clear view to take advantage of the confusion of others.

So let's start by listing the principal uncertainties and then whittling them down so that some of the fog can be cleared. There is UK politics of course; but there is also the direction of the EU as shown by the Cannes summit; there is the balance of the UK economy; and there is the growing possibility of a global slowdown, including the chance of recession in the US.

Perhaps the only sensible thing to say about UK politics is that the possible date of the general election has been brought forward. Everyone can have their own view about the chances of this government winning another general election, or of this prime minister leading the conservatives into that election. There is no new information here of any quality, for no one knows what is going to happen over the next two or three weeks. Maybe there is more uncertainty about UK policy towards Europe, but that policy was moving anyway.

What is quite new is the fact that we have moved into a pre-election market about a year earlier than anyone could reasonably have expected: had he not called the leadership contest, Mr Major would have been secure until the end of this parliament. As it is, Ladbrokes yesterday were quoting little better than evens that he would stay in office. This raises the possibility not just of a new Tory leader, but one who would face an immediate vote of confidence in the Commons. The general election could conceivably come very soon, but even if it does not, the uncertainty will persist at a higher level until it does take place.

Next, the Cannes summit. The meeting has only just begun so there is no particular new information here yet, but there is one important thing to look for: French policy under a new president. Anything which signals a more nationalist approach by France will ease tensions over European policy in Britain.

Third, we have revised first-quarter figures for both gross domestic product and the current account. These are reported on page 20, but it is worth drawing attention to two things. One is the sharp rise in the savings ratio, which may well have continued through the second quarter and if so will have contributed to slower growth. The other is that the current account was not evidently in surplus at the end of last year but was and remains in modest deficit.

The main effect of these revisions is to clear up puzzles. If people were feeling as insecure as they were reported to be feeling, you would expect them to save more. Well, it seems they did. And those current account figures, showing a surplus, did seem rather surprising at the time. That is all helpful, for we now have a reasonable understanding of what has been happening in the past, a necessary precondition for understanding what might happen in the future. The new forecast from the Treasury tomorrow will tell us by how much growth this year has been scaled down, which will be helpful in making a judgement as to whether the next change in base rates will be up or down.

Global slowdown? Nothing new yesterday but wait for the forthcoming meeting of the Federal Reserve Open Market Committee on 5 and 6 July, and in particular whether it is followed by a half-per cent cut in both the Fed funds rate and the discount rate. If rates are cut, this could signal the peak of the dollar interest rate cycle, with obvious implications for us. But rates will only be cut if the Fed believes that there is serious danger of renewed US recession.

All this constitutes a much higher level of uncertainty than three months ago, when British and EU politics and the British and US economies all appeared quite settled. What should the ordinary business executive or investor make of this?

I suggest three rules: look long; look for the point in the cycle; and look for parallels.

Looking long means looking beyond our next general election. Whenever that happens two things are virtually certain. The budget deficit will come below the Maastricht requirement of 3 per cent of GDP and remain there; and the Bank of England will gain greater independence. Conclusion? Fiscal and monetary stability will be retained, even strengthened. That is very positive, for any current market weakness should be seen in that context.

Looking for the point in the cycle means accepting that the overwhelming probability is that the present expansion will continue, maybe after a pause this year, for another two years at least, perhaps longer. That is positive too.

Looking for parallels means looking at the US experience of a Democratic president following a Republican administration. Under President Clinton US markets have seen a sustained rally in share prices, which was unaffected by the subsequent triumph of the Republicans in the mid-term elections.

All this should surely be a powerful antidote to current uncertainties. It is quite difficult, when there is a whiff of panic in the air, to stand back and ask the tough question: has anything really changed? In UK politics things have undoubtedly changed; but nothing else has. And in the perspective of global financial markets, UK politics are not very important - however much fun it is to be a spectator at the squabble.