Slaying The Regulatory Hydra

The UK Chancellor of the Exchequer clearly believes that pre- emptive strike is his most effective weapon when dealing with the City of London. Within a month of taking office he has announced the most radical shake-up of the Bank of England since it was founded 303 years ago.

On the one hand, he will extend the Bank's powers by giving it operational responsibility for monetary policy. But with the other hand he has curbed its authority by removing its role as supervisor of the banking sector. This function will now be carried out by a revamped Securities and Investments Board. One of the reasons put forward for this change is that the boundaries between the banks and other financial institutions have become blurred in recent years.

The change in the Bank of England's remit is not the only change: there will be a widespread reorganization in the structure of financial regulation in the UK. At present there are three self- regulating organizations (SROs)--the Securities and Futures Authority (SFA), the Investment Management Regulatory Organization (IMRO) and the Personal Investment Authority (PIA). These bodies are responsible for policing their members and they, in turn, are supervised by SIB. The SROs are in effect autonomous bodies and SIB has few direct powers over them. There have been constant tussles between the different SROs and between individual SROs and SIB. The result has been neither efficient nor, more importantly, effective in protecting investors' interests.

On paper, therefore, there is much to recommend a complete overhaul of the financial system. For one thing, it will bring the UK central bank more into line with a number of the other G-7 countries. Mr. Brown has acknowledged that, in separating the Bank of England's supervisory and monetary functions, he is modelling the UK on the U.S. system. Countries such as Germany, France and Denmark also operate a dual system. But in all these countries the supervisory function is more fragmented than the one-stop regulator proposed for the UK. The new super-SIB will become one of the most powerful regulatory bodies in the world and other regulators will watch with interest to see whether such a multi-tentacled body can be effectively housed under one roof without becoming a bureaucratic nightmare.

The present financial regulatory hydra is hopelessly unwieldy and there needs to be a root and branch reform of the whole system. For practitioners and investors alike, the most important test for the new body will be whether it can achieve efficient, streamlined regulation without stifling innovation and becoming massively expensive. A balance must be struck between protection and over- cosseting investors. Investment has never been and never will be a risk-free business and it should not be the role of regulators to try and make it such.

End Of The Honeymoon?

Conventional wisdom in the currency markets has it that a change of government from Conservative to Labour in the UK results in an immediate opportunity for selling sterling. Not so on this occasion. The currency markets have taken the switch to the `New Labour' government of Tony Blair in their stride, buoyed up by the belief that the new administration is very much to the center of the political spectrum. This confidence was further boosted by the decision of the new Chancellor, Gordon Brown, to give the Bank of England independence to set the level of interest rates. The markets are now waiting for the forthcoming mini-budget to see what other far reaching measures the Chancellor may have in mind. It is in the combination of monetary and fiscal policies that potential problems for the pound may begin to appear. The Institute for Fiscal Studies in their "Green Budget" have suggested that there is little need for tax raising measures in this budget. But, politically, the most advantageous time to raise new revenue is after a sweeping election victory and Mr. Brown is unlikely to resist the temptation of winning his fiscal spurs from the market.

The likelihood, therefore, is that fiscal policy will become tighter.

Around the same time, the new policy committee of the Bank of England will be meeting to discuss interest rates. With consumer confidence high and the windfalls from de-mutualising building societies lining consumers' pockets, it is going to find it difficult to avoid raising interest rates--especially as the committee will also be keen to establish its own credibility with the markets. The next rate increase will probably be the first in a series of rate rises. The UK economy is therefore likely to be subjected to both a tight monetary and fiscal policy in the months ahead. Initially, this may benefit the pound but, as the economy slows, a sharp decline could follow.

Deutschemark/Sterling

Looking at the technical picture, one can see from both the dollar/sterling and Deutschemark/sterling charts that the trend for the pound is upward implying that long positions of sterling are still appropriate. In the case of the pound against the Deutschemarks the steep upward trend that had existed since September 1996 has been replaced by a channel with a much more gently sloping upward trend. The top of this channel is currently at Dm2.8640 whilst the lower end is at Dm2.7290 and rising at the rate of 15 points per day. As long as the pound remains above this line, the potential for further gains exists, but any break of this lower level would suggest that a sharp correction is in train and would provide a target of Dm2.5940. Strong support at Dm2.6630 and the 200-day moving average (currently at Dm2.5930) should ensure that any decline does not become a freefall. On the topside, it would need a break of resistance at Dm2.8075 to provide a test of the top of the channel.

Dollar/Sterling

The upward trend for dollar/sterling has been in existence since May of last year. It currently stands at $1.6090 and is rising at the rate of 10 points a day. The upper level is currently constrained by the trendline at $1.6615, leaving the pound with an upward bias, but trading within a relatively narrow range. The 200- day moving average also sits within this range at $1.6205. The ability of the rate to move higher looks limited with a break of $1.6615 only targeting $1.6710. Indeed the wedge shape of the pattern gives a slight downward risk to the pound in the longer term but it would need a break of the 200-day moving average and the lower trendline to confirm this. The immediate objective would then become the support area at $1.5855, with a break of this level then targeting $1.5370.

June 2, 1997
Berkeley Futures, Ltd.
38 Dover Street,
London, UK, W1X 3RB

Relocated 06-13-97
Last updated on 06-13-97

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