Europe and the UK
The exuberant start to 2007 was quickly squelched after Tuesday's robust beginning to the New Year. European shares hit their highest levels since February 2001 despite low volumes. Both U.S. and Japanese markets were closed and there was little in the way of fresh economic data to provide momentum. Stocks that were targeted as possible takeover candidates or picked to be strong performers in 2007 flourished. Bankers are predicting another strong year of mergers and acquisitions after record merger and acquisitions activity in 2006. Tuesday's gains offset the rest of the week's declines for the most part. Both the CAC and DAX were down less than 0.5 percent on the week while the FTSE barely missed breaking even.

In December, the UK service sector grew at its fastest pace in nearly a decade with firms hiring new staff at a rate not seen since the summer of 1997. Sterling rebounded somewhat as analysts reasoned that the better-than-expected data would add pressure for the Bank of England to raise interest rates again, probably at its February meeting. Retailers added to the positive news saying they had a better-than-expected Christmas shopping season. These two reports underlined consumer strength within the economy.

Asia/Pacific
Asian/Pacific stocks ended the week mostly on the downside. But only stocks in Hong Kong and Singapore were up on the week. The Australia's all ordinaries index was hit hard by the declines in commodity prices that affected producers' stocks. In Japan, stocks traded only on Thursday and Friday as markets were closed for traditional New Year's holidays earlier in the week. The graph below pictures the Nikkei since 1981 and the Hang Seng since its inception in 1984. While the Hang Seng has been at or near new long term highs, the Nikkei has a long way to go to equal the ethereal heights of its bubble years.

Canada
The Canadian dollar and the Canadian stock market have been feeling the brunt of recent commodity price fluctuations. The Canadian dollar, which tends to follow commodity prices, dropped to an 11-month low on speculation that declining prices might cause the currency's decline to accelerate. The currency tends to follow the price of commodities, which account for about 54 percent of Canada's exports. Crude oil fell to its lowest level in more than six weeks as mild U.S. weather curbed heating-fuel consumption, while copper dropped to an eight-month low as investors speculated prices were exaggerated. Stocks also have declined from record highs under the pressure from lower commodity prices with producers share prices being particularly hard hit. The S&P/TSX composite sank by 430.42 points or 3.3 percent in this holiday shortened week. Energy shares account for more than 25 percent of the index's value.

The Canadian dollar fell for a fourth straight month in December and last year saw its first annual decline in five years as the economy slowed and crude oil ended a four-year rally. The currency has dropped about 6.5 percent since its 2006 high of over 91 U.S. cents on May 31st - which was the highest since 1978. The Canadian dollar was trading at 85.3 U.S. cents near today's close.

Currencies
Countries with large holdings of dollars in their foreign-exchange reserves are showing a new openness to selling the dollar in favor of the euro. The latest to do so is the United Arab Emirates, which joined Russia, Switzerland, Venezuela and others late last month when it shifted some of its reserves into euros. There have also been some signs from China about following suit also. And recently, Iran, the world's fourth largest oil producer, said that it would prefer to be paid in euros rather than the usual dollars for its oil shipments (all oil transactions are conducted in U.S. dollars). But analysts say these moves are unlikely to do any long-term damage to the dollar. Central banks that are adding other currencies to their reserves do not appear to be driven by a belief that the euro will eventually supplant the dollar as the world's key currency. Rather, they are doing what investors typically do to minimize risk - they are diversifying. The amounts moved so far have been relatively small when placed in perspective to a global market that trades trillions of dollars a day.

One reason that dollar outflow isn't likely to turn into an avalanche is that foreign countries would risk devaluing their dollar-denominated investments. Even a slight suggestion that a central bank is thinking about swapping dollars for euros can push the dollar down in the spot markets, and in turn hurt all foreign investors in American securities. It also is in China's best interest not to let the dollar's value slip. Heavy sales of the dollar could make it harder for the country to manage its gradual appreciation of the yuan against the dollar. Anything more abrupt would make Chinese goods less competitive in the United States and pose problems domestically for some of its state banks, limiting their ability to borrow.

One major issue driving investors away from the dollar is the possibility that interest rates in the United States and Europe may move farther apart next year. The financial markets are currently expecting at least one interest-rate cut by the Federal Reserve in contrast to predictions of further interest-rate increases by the European Central Bank. Because returns typically rise with interest rates, the euro seems like a more attractive investment.

The yen has come under pressure in recent months amid continued appetite for carry trades, where long positions in higher-yielding currencies are funded by borrowing cheaply in low-yielding currencies such as the yen. However, the yen's sudden climb this week has posed some questions about its cause. Some analysts pointed to the sharp drop in oil prices, which should favor Asia's energy importers. Others, however, think the yen's increase was sparked by comments from Japan's finance minister, Koji Omi. He appeared to pave the way for a much-anticipated Japanese interest rate increase by saying that it was up to the Bank of Japan to decide whether to tighten monetary policy.

Indicator scoreboard
EMU - December flash harmonized index of consumer prices was up 1.9 percent when compared with the same month a year ago. This was the fourth month that the reading came in below the European Central Bank's 2 percent inflation ceiling target. As with all flash reports, no detail was available. The easing of consumer prices has resulted from lower energy prices, but upward pressure on the HICP is expected because of the increase in German VAT that went into effect on January 1, 2007.

November retail sales were up 0.5 percent and 1.3 percent when compared with the same month a year ago. Food sales were up 0.4 percent and non-food sales were up 0.5 percent. Monthly sales in Finland jumped by 1.5 percent and in Spain and Luxembourg by 0.9 percent.

November unemployment rate edged down to a record 7.6 percent from 7.7 percent in the previous month. Unemployment declined in Germany, France and Greece. It should be noted that these data are based on Eurostat's harmonized methodology and do not coincide with national unemployment data. For example, German national data show the November unemployment rate as 10.1 percent, significantly above the harmonized rate of 8 percent reported today.

November producer price index was flat on the month and up 4.3 percent when compared with last year. Lower energy prices offset increases elsewhere. Energy prices were down 0.3 percent after declining 0.5 percent in the previous month. Excluding energy, the PPI edged up 0.1 percent and 3.5 percent on the year.

EU - December economic confidence index edged downward to 110.1 from 110.3 in November. Industrial sentiment was unchanged at 6 while consumer sentiment was down a notch to minus 7 from minus 6 in the previous month. Services sentiment was unchanged while retail sentiment deteriorated to zero from plus 3 in the previous month.

Germany - December seasonally adjusted unemployment dropped by 108,000 resulting in an unemployment rate of 9.8 percent. This was the eighth decline in nine months. Unemployment declined by 74,000 in the West and a drop of 34,000 in the East. The unemployment rate in the West slipped to 8.2 percent from 8.4 percent in November. The unemployment rate in the East dropped to 16.2 percent from 16.6 percent in the prior month. November employment (these data lag unemployment by a month) was up 46,000.

Americas
Canada - November industrial product price index was unchanged and up 1.9 percent when compared with the same month a year ago. On the month, lower prices for primary metal products and petroleum products were offset by higher prices for chemical products, fruit, vegetables and feed products and pulp and paper products. On the year, upward pressure came mainly from higher prices for primary metal products, pulp and paper products as well as fruit, vegetable and feed products.

November raw materials price index was up 0.9 percent after declining for three months. The increase was due to higher costs for mineral fuels, non-ferrous metals as well as vegetable products. The RMPI was up 4.6 percent when compared with last year, a significant change from the year-over-year increase of 2.2 percent in the previous month. On the month, decreases in primary metal and petroleum products prices were offset by higher prices for chemical products, fruit, vegetable and feed products as well as pulp and paper products.

The value of the Canadian dollar against the U.S. dollar declined 0.7 percent in November. As a result, the total IPPI excluding the effect of the exchange would have been down 0.2 percent instead of remaining unchanged. On a 12-month basis, the value of the Canadian dollar was up 3.9 percent against the U.S. dollar. If the impact of the exchange rate had been excluded, producer prices would have risen 3.0 percent on the year.

December employment soared by 61,600 jobs. Full time employment was up 36,900 jobs while part time employment increased by 24,800 jobs. The unemployment rate was 6.1 percent, down from November's 6.3 percent rate. Statistics Canada said that employment was up for the 14th consecutive year, increasing by 2.1 percent. Manufacturing employment was up 10,100 in December but was down by 59,000 jobs for all of 2006. The losses were primarily in the main industrial provinces of Ontario and Quebec.

Bottom line
A holiday shortened week provided little new economic information. The features of the week were the U.S. and Canadian employment reports. Both showed larger than anticipated employment gains. While the unemployment rate maintained the status quo in the U.S. at 4.5 percent, the Canadian rate declined to 6.1 percent.

With the onset of the New Year, Prime Minister Andrea Merkel begins an important year for Germany. Germany assumed the rotating presidency of the European Union on January 1st for six months. One item on Ms. Merkel's EU agenda is to revive the constitution that went down in defeat in 2005. Ironically, one of the changes that the constitution would provide for is a permanent president of the EU. Germany is also chair of the Group of Seven in 2007. Among its duties will be hosting the G-7 summit slated to be held in Heiligendamm, Germany on June 6 through 8.

A full slate of indicators - many catch up from the holiday period - will be released this week. They in turn will serve as input to upcoming central bank policy decisions. A full slate of central bank meetings is on the agenda with all but the Reserve Bank of Australia holding their regularly scheduled meetings. The RBA is observing its traditional mid-summer vacation break. Neither the Bank of England nor the European Central Bank is expected to change policy in January. However, that is likely to change in February.

Looking Ahead: January 8 through January 12, 2007