Volatility likely to get worse in coming weeks

This week's turbulent market events have shown that the effects of the credit crunch are far from being over at the same time as inflationary concerns intensify, according to Jeremy Tigue, manager of the Foreign & Colonial Investment Trust.

"Yesterday Fed chairman Ben Bernanke painted a very uncertain outlook for the economy and investors agreed with him as share prices, particularly in banks, moved up and down with ever increasing gyrations, " he said.

In the US concerns that Fannie Mae and Freddie Mac would become insolvent under the weight of non performing mortgages and falling house prices led to unprecedented government support and an explicit acknowledgment that the US government would stand behind them.

"This is like Northern Rock but on a far greater scale and with far greater potential consequences," he commented. "If their debts are added to the US national debt, overseas investors may take fright and put pressure on the dollar." According to Tigue, this potential outflow of foreign investors' money would put upward pressure on inflation, making interest rate cuts impossible and rate rises highly likely, with the consequent negative impact on the economy.

Regarding the UK, he commented: "The housing market in the UK is several months behind the US and everyone is nervous that the banking sector over here will experience similar pressures. Inflation news this week was disappointing and interest rate cuts by the Bank of England look a long way off."

However, amidst the general gloom and turmoil there were two positive signs. First of all, the oil price has fallen over the last few days as US demand slowed down and inventories increased. Secondly, the US bank Wells Fargo announced better than expected results leading to a huge rally in US banking stocks.

"A lower oil price would be unambiguously good news for markets," Tigue said. "The rally in bank shares shows how easily share prices can move in both direction and also just how much bad news is factored into current valuations."

He concluded: "The summer holiday season is now well under way so this volatility is likely to get worse in the next few weeks."