New British Chancellor Gordon Brown has proved capable of producing surprises, with one analyst believing that investors are reserving judgement on what sectors to favour until after the mini-budget.

But most UK investors had already taken account of the change in government long before the election.

UK economist at Salomon Brothers, Michael Saunders welcomes both last month's quarter-point rise in interest rates and independence for the Bank of England. Rates probably need to go up a little more. The economy is growing reasonably strongly and we have been through this cycle enough times. It makes sense to be edging them up. Independence for the bank increases the chance of early action against signs of inflation pressures, not just this year or next but over a longer period."

Ideally he would like to see fiscal policy tightened rather than interest rates overused, but admits that with the PSBR undershooting this is difficult to justify.

"I doubt if the Chancellor is going to do a really big fiscal tightening to hit consumer spending and by big I mean £5bn-7bn ($8bn-11bn). Labour would seem to be in breach of the spirit if not the letter of their election promises," he says.

He does not believe that bonds will rise much further. "I have been bullish on gilts for a while but the market has rallied a lot and the yield curve is fairly flat. Inflation is going to be very low this year and yields will not rise sharply."

Andrew Smith, chief economist at Credit Lyonnais Laing agrees with this assessment adding: "The rally in bonds following the Bank of England announcement, has gone a bit far and may unwind later this year."

For equities, Philip Wolstencroft, UK strategist at Merrill Lynch, is still reasonably bullish with a year-end target for the FTSE of 5,000.

With bond yields going sideways and reasonable earnings growth, the market should carry on going up.

Much of the reason, he says, lies with lots of technical indicators still giving buy signals, citing the example that in the first two weeks of May, directors' buying shares exceeded those selling by two and a half times, a strong buy signal which often presages a reduction in rights issues thus squeezing up prices.

In terms of sectors, Wolstencroft favours financials "which keep delivering pleasant surprises on reasonable yields with strong dividend growth". He is keen on electricity, aerospace, where there are big up trends in for profits and dividends, and transport.

He is underweighting pharmaceuticals, media and oil. Smith is more circumspect: "Banks, utilities and pharmaceuticals have been leading the market up. I would stay with the banks. But no-one is quite sure what to switch to. Consumer type stocks do well during strong consumer spending but interest rates are going up. Manufacturing should be benefiting from stronger growth but the pound is very strong. This puts a block on the normal switching through sectors we usually see during the cycle.

"Utilities and pharmaceuticals - non-cyclicals - rather perversely are doing ex-tremely well even when the economy is accelerating."

Smith believes that invest-ors are watching the budget for changes to corporation and advance corporation tax.

"Until you actually know what this is going to be, it is very difficult to make any recommendations sector wise," he says. "It will come down to the financial positions of individual companies. I suspect this is another reason, why the market, in turns of what is going up, is paralysed."

John Lappin"

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