FINANCIAL DEVELOPMENTS

Sterling

1.61 The sterling index, which measures the sterling exchange rate against a basket of currencies, has strengthened by over 3 1/2 per cent since the end of last year. Sterling has remained relatively flat against the dollar, but has risen against the deutschmark and the Yen.

Interest rates

1.62 Since the Budget, base rates have been cut four times (by 1/4 per cent in December, January, March and June) to 5 3/4 per cent. Mortgage rates have fallen by nearly 1 1/2 per cent over the last year.

Long rates

1.63 UK long rates have risen slightly since the beginning of the year, reflecting increases in long rates abroad. Yields on 10 year gilts averaged 8 per cent in June, up from 7 1/2 per cent in January.

Monetary aggregates

1.64 The 12-month growth rate of M0 slowed slightly last year, but has quickened again in recent months and remains above its monitoring range. But there may have been a structural change in M0's velocity trend relative to GDP, so that faster M0 growth than previously is now consistent with the inflation target. This could reflect a combination of a slowdown in the rate of financial innovation over recent years and the shift to a low inflation environment. However, it is unclear whether this structural shift will be temporary or permanent, and it is hard to assess the implications for activity and inflation from recent trends.

1.65 The 12-month growth rate of M4 has risen sharply since the beginning of 1995, reaching 10 per cent in May. To some extent, this acceleration reflects the introduction in January of the gilt repo market, which contributed to a sharp rise in the deposits and borrowing of other financial institutions. However, industrial and commercial companies and persons have also been building up deposits. In the case of companies, this partly reflects spending on mergers and acquisitions (which was higher last year than in any year since 1989), but it may also foreshadow higher company spending on investment and stocks. The build up of personal deposits is consistent with strengthening consumer demand.

Asset prices

1.66 Rising equity and house prices will also tend to boost consumer demand. The FT-SE All-Share index fell by 12 per cent between January 1994 and January 1995, but it has since risen by about a quarter, to a new high. The commercial property market is still subdued, but capital values seem to have levelled out after falling sharply during 1994, and rental values are beginning to rise.