A small player but we're in a global club

Published on Saturday 5 May 2007 01:06

THE Investment Club has unfortunately been caught up in the world currency market turmoil and this has adversely affected its unit price, which has fallen by 2p to 237p.

This interpretation may sound a bit grand for an insignificant little investment club but it is more a demonstration of how, when the macro-economic picture has no dominant force, the volatility caused has a negative impact on the minnows.

For instance, conventional economic wisdom has it that, all things being equal, if country A increases its interest rates relative to country B, then A's exchange rate will appreciate relative to B.

Add to this analysis expectations of importers and exporters, financial institutions and central banks, plus politicians' agendas, and it is less clearly delineated which force is establishing supremacy.

In the UK, the Bank of England has been inching up interest rates to try to keep a lid on inflation. In turn, high interest rates have sent the pound higher.

The rise in both the pound and interest rates should have stemmed the increase in inflation. However, the Retail Price Index has shot up 4.8 per cent, suggesting inflation is out of control. Expectations of higher inflation should in theory mean the pound should fall in value. Contrarily, the pound is at its highest level against the dollar since September 1992, in spite of subdued inflation in the US.

Which force will dominate and can the club survive?

If the Bank puts interest rates up by a mere quarter point on Thursday, then nobody will believe it is serious about controlling inflation, bonds will have a big fall, and the club's unit price will plunge. A half-point rise would be a neutral move, but would probably move the pound up and leave the debt market unmoved. The best outcome for the club's survival would be an increase of three quarters of a point. This would send a strong message that profligacy has to stop.