Europe and the UK
Stocks in Europe and the UK were down for the second week in three until the release of the Reuters/University of Michigan consumer sentiment index on Friday morning. The CAC, DAX and FTSE staged rallies but neither the FTSE nor the CAC were able to recover all of the week's losses. On Thursday, an otherwise positive day turned negative after Federal Reserve Chairman Ben S. Bernanke said the U.S. government may face a fiscal crisis in the coming decades. However, in London, UK stocks were able to salvage the day thanks to mining companies who responded to higher metal prices. The CAC and FTSE were barely down on the week while the DAX was up thanks to merger prospects.

Bank of England redux
Data last week in the UK reinforced the need for the Bank of England's surprise rate increase on January 11. Consumer prices soared by 3 percent on the year while retail sales volumes increased more in December than they had in three years. The Monetary Policy Committee had access to the CPI data for their meeting. The Bank has an inflation target of 2 percent. Should inflation be more than 1 percent higher (or lower) than their target, Bank of England governor Mervyn King is required to write a public letter of explanation to the Chancellor of the Exchequer discussing the problem and what action will be taken to bring inflation back within target. With the Bank's key interest rate at 5.25 percent, housing builders' stocks declined on the interest rate outlook, which appears to be on the upside given the UK's strong growth prospects and climbing inflation.

Asia/Pacific
Contrary to the indexes followed here in North America and Europe, five of six Asian/Pacific indexes were up solidly last week. The laggard was the Kospi as technology companies such as Samsung retreated. The decline was in response to disappointing IBM hardware sales that trailed analyst estimates. Earlier in the week, Intel released earnings projections that missed forecasts as well. Some analysts expect the global technology industry to slow in the first half of 2007, and as a result some investors reduced their holdings. Asian drug makers such as Takeda Pharmaceutical gained thanks to merger talks which in turn boosted speculation that there are more industry combinations to come. The Hang Seng index continues to be a top performer, gaining 3.6 percent on the week.

In Japan, initial disappointment that the Bank of Japan did not increase rates led investors to sell bank stocks that had been purchased earlier in anticipation of a rate increase. However, these sales were offset by purchases of shares in companies such as Mitsubishi Estate, Japan's biggest developer, simply because rates did not go up and despite the uncertainty about when the Bank might finally increase rates. Equities were relatively unaffected by the Bank of Japan's decision to leave rates unchanged because it had already been priced into the market.

Bank of Japan - not yet
The Bank of Japan left its policy interest rate at 0.25 percent after its two-day meeting. The bank had been widely expected to increase rates by 25 basis points to 0.5 percent until just prior to the start of the meeting. In its post-meeting statement, the Monetary Policy Board cited mixed economic signals as their reason for leaving rates unchanged. The Bank's board voted six to three against a rate increase. The split vote suggests the bank may be preparing to raise rates in February, by which time new data are expected to show the economy performing well in the fourth quarter. Dissenters from the majority opinion might have also been lodging a protest against what is widely viewed as the government's heavy-handed campaign against a rate increase.

Prior to the meeting, the BoJ was under intense pressure from various government officials to leave rates unchanged. While Japanese economic data have been weaker than expected, many called into question the Bank's independence given the blatant political pressures exerted by the government. The bank, which won its independence only in the late 1990s, has previously resisted such pressure, but this week, appeared to back down. Bank Governor Toshihiko Fukui denied that the bank had caved in to the politicians. In his post-meeting statement he said, "As always, today's decision is based on our careful assessment of the economy and prices. There is no room for factors other than economic and price conditions to wield clout over monetary policy."

In the weeks prior to the meeting, the Bank had appeared to be preparing the markets for a rate increase via officials' speeches. This in turn triggered a strong government response. They said that the Bank should support the government's growth policy by keeping monetary policy loose. This would also allow the government to pay less to maintain its huge deficit through lower interest costs. The government also argued that the economy has not decisively escaped deflation. The core consumer price index, excluding fresh food, rose just 0.2 percent in November. Excluding energy, prices are still falling.

Canada - Bank of Canada on an even keel
As expected, the Bank of Canada kept its key interest rate at 4.25 percent for a fifth meeting. In explaining its action, the Bank said that the risks to the economy from an export slowdown or a housing boom have diminished and remain roughly in balance. The Bank also maintained that risks to its inflation projection are roughly balanced. The Bank of Canada maintains an inflation target range from 1 percent to 3 percent focusing on the 2 percent midpoint. Exports slowed in 2006 as the high value of the Canadian dollar made the country's goods more expensive. The Canadian dollar's value also helped control inflation in an economy with record demand for new homes and energy and a tight labor market.

Currencies
The yen continued to be pummeled in the world's foreign exchange markets last week. The currency took the brunt of market criticism of the Bank of Japan's inaction on interest rates. Many analysts are wondering how low the yen can go. Further deterioration could occur as market players question the Bank of Japan's credibility especially if the Bank responded to political pressure. The Bank of Japan gained its independence at the same time as the Japanese 'Big Bang" in the late 1990s. Until that time it was part of the Ministry of Finance. BoJ has struggled since to assert its independence and this is not the first time it has been questioned. Since the BoJ's policy announcement, many analysts have cut their forecasts for the yen. The yen lost about 2 percent against the dollar and about 11 percent against the euro in 2006 as investors used the currency for carry trade transactions. They borrowed yen to purchase higher-yielding assets elsewhere. The differences are substantial with rates varying, for example, from 6.25 percent in Australia, 5.25 percent in the U.S. and UK and 3.5 percent in the eurozone when compared with Japan's 0.25 percent. The yen steadied Friday after discussion shifted to whether the Bank of Japan just merely postponed the increase until February.

Indicator scoreboard
EMU - December harmonized index of consumer prices was up 0.4 percent and 1.9 percent when compared with last year. Prices were up for seasonal tourism, hotels and restaurants. Core HICP which excludes food, energy, alcohol and tobacco was up 1.5 percent on the year. The Core measure that excludes only energy was up 1.8 percent on the year.

November unadjusted merchandise trade surplus was €3.1 billion, virtually unchanged from October. Exports were up 0.9 percent while imports were up 0.8 percent on the month. On a seasonally adjusted basis, the surplus was €4.5 billion, almost double that of the previous month.

November industrial output was up 0.2 percent and 2.5 percent when compared with last year. German output propelled the gain in overall EMU output while French and Italy output declined. Consumer durables were up 1 percent while capital goods were up 1.2 percent and energy gained 0.9 percent. Nondurables output was unchanged.

Germany - January ZEW expectations index climbed to minus 3.6 from minus 19 in December. The current conditions index set a new high of 70.6. ZEW said the index's improvement was due mainly to better labor market conditions. Increasing investment demand also contributed to improved sentiment. The ZEW surveyed 282 German financial experts for their opinions on current economic conditions and the economic outlook for major industrial economies between December 27 and January 15.

Britain - December producer output prices edged up 0.2 percent and 2.2 percent when compared with last year. Core output prices, which exclude food, alcohol, tobacco and petroleum, was up 0.1 percent and 2.3 percent on the year. Food prices were up 0.4 percent and gasoline prices jumped by 1.2 percent reflecting an increase in taxes. Input prices were up 0.1 percent and 1.9 percent on the year.

December consumer price index (the Bank of England's current inflation measure) was up 0.6 percent and 3 percent when compared with last year. Prices of fuels and lubricants were up in large part reflecting the increase in fuel duty which came into effect on December 6. The 3 percent increase was the highest on record. Furniture and household goods prices showed their largest monthly increase since the start of the official series in January 1997 as retailers raised their prices across a broad range of items prior to the usual January sales period. Retail price index excluding mortgage interest payments (the Bank of England's previous inflation measure) was up 3.8 percent while the retail price index was up 4.4 percent on the year. Housing costs which are excluded from the CPI had a large upward effect on the index.

December claimant count unemployment declined by 5,500, leaving the claimant count unemployment rate unchanged at 3 percent for the 10th month. September-through-November unemployment (as measured by International Labour Organisation definition) dropped by 29,000 when compared with the previous three months. The unemployment rate remained at 5.5 percent for the second month.

Average earnings for the three month to November were up 4.1 percent when compared to the same three months a year ago. Excluding bonuses, earnings were up 3.7 percent. November earnings were up 3.9 percent. Excluding bonuses, earning were up 3.6 percent.

December retail sales volumes were up 1.1 percent and 3.7 percent when compared with December 2006. Non-food store sales were up 1.4 percent while food stores increased 0.6 percent. The best performer was household goods, which increased by 5.2 percent on the month boosted by particularly strong demand for electrical items. Sales at non-store retailers, which encompass online purchases, were up 1.7 percent.

Asia
Japan - December corporate goods price index was unchanged on the month and up 2.5 percent when compared with last year. The export price index, which is released at the same time, was down for the third month but was positive on the year.

November tertiary index was down 0.3 percent but up 1.1 percent when compared with last year. The index is a gauge of service sector output and mirrors recent listless consumer spending. Hotels and restaurant activity was down 2.1 percent while information and communications services companies output dropped 2.6 percent and financial and insurance services firms declined 2.0 percent. The tertiary index measures activity in 11 service industries, including utilities, transportation, telecommunications, wholesale and retail. Output in the tertiary industries accounts for 60 percent of Japan's gross domestic product.

Americas
Canada - November factory shipments were up 2.3 percent but down 0.7 percent when compared with the same month a year ago. Taking price fluctuations into account, the volume of shipments increased 2.0 percent. Thirteen sectors, representing 73 percent of total output, increased. Durable goods shipments jumped by 3.1 percent while nondurable goods shipments were up 1.3 percent. Motor vehicle shipments soared 13.7 percent after new models were introduced. Shipments from refineries increased by 4.6 percent. New orders were up 2.3 percent primarily thanks to a surge in transportation equipment orders. Excluding transportation, new orders barely would have edged up. Unfilled orders were up 2.3 percent also, again due to the transportation equipment sector where high value and time lags typically account for half of all unfilled orders in the manufacturing sector.

Bottom line
This past week was highlighted by the Banks of Canada and Japan monetary policy announcements. Both kept their policy rates unchanged at 4.25 percent and 0.25 percent respectively. Last week's data from the UK justified the Bank of England's surprise interest rate increase of January 11. The CPI recorded a 3 percent increase on the year, a full percentage point above the UK inflation target. Other data corroborated growth in the UK during the fourth quarter including fewer people unemployed and positive manufacturing growth. Their first estimate of fourth quarter gross domestic product will be released at the end of this week.

The economic indicator load is lighter this week. Among the highlights will be the Ifo survey from Germany. An improved reading is expected. There are no major central bank meetings this week. However, the FOMC meets January 30th and 31st.

Looking Ahead: January 22 through January 26, 2007