After backing down in January, the Bank of Japan's Monetary Policy Board voted 8 to 1 to increase its key interest rate by 25 basis points to 0.5 percent. Despite the doubling, short-term rates remain incredibly low. While some market players viewed the move with relief - it ended the uncertainly surrounding BoJ policy - others viewed it as a gamble. Expectations that a tight labor market would force profit-rich companies to raise wages has not happened. Nor has there been upward pressure on prices; but declining oil prices have played a role here also. In its statement explaining its move the BoJ said that the decision was partially based on strong fourth quarter GDP growth. They decided that the summer's weakness in private consumption was temporary. While some board members are nervous that the economy is not progressing quite as they had expected, they are even more worried about what they regard as the negative consequences of keeping monetary policy too easy for too long. These include distortions to the money markets and to risk allocation, with the associated (and dreaded) potential for asset bubbles. Political comments were muted this month, unlike in January when the Bank was on the receiving end of heavy political pressure to leave interest rates unchanged. By lifting its interest rate, the BoJ is trying to regain some of the credibility it lost after apparently bowing to political pressure not to raise rates last time around.
On the surface, the move makes carry trades, where speculators borrow in yen and invest in higher yielding currencies, slightly less attractive. But the extra quarter percent doesn't do much to undermine carry trade profitability because it probably will be outweighed by rising rates elsewhere. With rates still so low, the ramifications of the move are modest. Of more interest was Governor Toshihiko Fukui's sober assessment of Japan's economic recovery. He said that rates would go up gradually.
Global Markets
Stocks continue to perform favorably but with occasional glitches. All Asian/Pacific indexes followed here were up on the week, while the FTSE edged down in Europe. Only the Dow declined on the week in North America. On the year, all indexes are in positive territory as the end of the second month nears. With economic data calendars light, investors focused on central bank activities - and especially those of the Bank of Japan. Minutes from both the Federal Reserve and the Bank of England described the rationale behind their decisions to leave rates unchanged at 5.25 percent.
Global Stock Market Recap
Europe and the UK
European stocks had a lackluster week in spite of gains for oil stocks after crude prices increased. The DAX offset losses incurred on Tuesday and Wednesday to finish the week up by 35.5 points or 0.5 percent while the CAC barely made it into positive territory by 3 points. The FTSE was not that lucky - it lost 18 points or 0.3 percent on the week. The banking sector dragged the FTSE lower on Friday as results from Lloyds TSB failed to impress investors. Revenues were pressured by record UK loan defaults. Losses for banking shares limited gains elsewhere as well. However, this was partially offset both in Europe and the UK by commodity producers' gains, thanks to higher metal and oil prices at the end of the week.
Bank of England explains rate decision
Minutes of the February meeting of the Monetary Policy Committee, the interest rate setting body of the Bank of England were released on Wednesday. Two MPC members voted for an interest rate increase but the majority expressed concern that another increase might be considered excessive. The majority thought that although there was limited spare capacity within the economy as well as a tightening labor market, there had, nevertheless, been little movement in pay settlements. The committee noted that inflation had been volatile over recent months. In conclusion, the majority felt it was a good idea to wait before taking further action, allowing recent rate increases to do their work.
Asia/Pacific
Asian markets celebrated the Year of the Pig last week in two ways. Markets in Singapore, Hong Kong and South Korea were shut tight at the beginning of the week, and upon reopening, the celebrants bought stocks. Several indexes reached new highs, among them the STI, all ordinaries and Topix. At week's end though, all indexes followed here had healthy gains. And as February trading draws to a close, Singapore's STI is the best performer. It is up a hefty 10.9 percent, eclipsing the Mexican Bolsa's gain of 7.8 percent. The STI gained 27.2 percent for all of 2006 and the Bolsa, 48.6 percent.
Japanese indexes responded favorably to the Bank of Japan's move. Unlike those in the currency market, investors here were pleased that the Bank said that future increases would occur only very gradually. Exporters' stocks rallied when the yen dropped on the same news. A lower valued yen helps boost competitiveness and repatriated profits. With the Japanese fiscal year ending in a month, the value of repatriated profits looms large for investors.
The Topix has rebounded from its poor performance in 2007. The index has gained 8 percent so far in 2007 and is the second best performer here. This is in sharp contrast to 2006 when the index managed, thanks only to a December gain, to edge up 1.9 percent.
The Australian all ordinaries has also set new highs in 2007. The index is up a hefty 6.5 percent this year after gaining 20 percent in 2006. The index has benefited from intense demand for commodities and metals especially in Asia and from a vibrant consumer sector.
Currencies
Most of the reaction to the Bank of Japan's interest rate move was in the currency markets where the yen continued to be battered. On Wednesday immediately after the announcement, the yen dropped to a record low against the euro and neared its weakest level in four years against the dollar after the BoJ said further increases would be gradual. Investors pushed the currency to near the lowest in a decade against the Australian dollar. The lowest interest rates among the major economies helps diminish the allure of yen-denominated assets. Carry trade escaped relatively unscathed since the likelihood of further interest rate increases elsewhere will probably offset any in Japan. On Thursday, the yen continued to be battered but stocks were up amid expectations that there would be no interest rate increase for some time to come.
Indicator scoreboard
Germany - January producer price index was unchanged on the month and up 3.2 percent when compared with last year. Excluding energy, the PPI was up 0.2 percent and 2.9 percent on the year. Increases in the prices of electricity, cement, livestock feed, iron & steel pipes, machines and furniture were offset by lower prices for petroleum products, natural gas, domestically produced oil, pork, pharmaceutical products and data processing equipment.
Fourth quarter gross domestic product was up 0.9 percent and 3.7 percent when compared with last year. This was unrevised from last week's flash estimate. Investment, responsible for most of the growth, was up 1 percent on the quarter with buildings up 1.2 percent, equipment up 0.5 percent and other investment up 2.7 percent. However private consumption was up a weak 0.3 percent. Domestic demand was down 1.3 percent on the quarter.
February Ifo sentiment index edged down to 107 from 107.9. This was the second monthly decline. Both the current conditions and six-month outlook indexes weakened. Current conditions declined to 11.6 from 112.8 while expectations dropped to 102.6 from 103.2. Ifo said that the value added tax increase that took effect on the first of the year had a negative impact on sentiment, especially in the retail sector. Manufacturing sentiment was down as a further improvement in current conditions was more than offset by a fall in expectations.
France - Fourth quarter gross domestic product was up 0.6 percent and 2.2 percent when compared with last year. This was a vast improvement over the third quarter which was unchanged and up 1.8 percent on the year. Growth was supported by business investment, up 1.1 percent on the quarter and 3.8 percent on the year. Household consumption was up 0.3 percent on the quarter and 2.7 percent on the year. Consumer investment cooled to a gain of 0.3 percent and 2.5 percent on the year.
January consumption of manufactured goods jumped for a second month by 1.2 percent and was up 7.1 percent when compared with the same month a year ago. Sales were up for all sectors with the exception of autos which were down 1.4 percent. Home entertainment & computer systems, appliances & furniture soared by 4.2 percent and were 26.3 percent higher on the year. Clothing spending increased 2.9 percent thanks to New Year's clearance sales. On the weak side were other manufactured goods, which make up 40 percent of total outlays. They edged up a mere 0.1 percent and 0.2 percent on the year.
Britain - Fourth quarter gross domestic product increased 0.8 percent and 3 percent when compared with the same quarter a year ago. Household spending was the growth driver and increased 1 percent and 2.6 percent on the year. Investment or gross fixed capital formation was up 2.5 percent and 7.2 percent on the year. Business investment soared by 11.1 percent on the year. The GDP deflator was up 0.7 percent and 2.4 percent on the year.
Asia
Japan - January unadjusted merchandise trade surplus was ¥4.4 billion when compared with a year ago. Exports were up 18.9 percent on the year while imports were up 10.9 percent. Exports to the United States increased 5.5 percent from a year earlier while those to China soared by 50.8 percent. On a seasonally adjusted basis, the trade surplus was ¥1,086 billion, up from ¥712 billion in December. Exports were up 3.3 percent while imports were down 2.6 percent on the month.
Americas
Canada - January unadjusted consumer price index was up 0.1 percent and 1.2 percent when compared with the same month a year ago. Excluding food and energy, the core CPI was unchanged on the month and up 1.7 percent on the year. Energy prices were down 1.6 percent and dropped 5.6 percent on the year. Clothing prices were up 0.7 percent while tobacco & alcohol product prices jumped by 0.9 percent. The Bank of Canada uses a core CPI for operational purposes which exclude eight volatile items. This measure was up 0.1 percent and 2.1 percent on the year. The Bank of Canada has an inflation target range of 1 percent to 3 percent focusing on the 2 percent midpoint.
December retail sales soared 2.3 percent and were up 6.7 percent when compared with the same month a year ago. Excluding autos, sales jumped 2 percent and were up 6 percent on the year. The December jump was highest monthly gain for retailers in nine years with widespread increases in all eight retail sectors. For the year 2006, sales were up 6.4 percent from 2006 - the highest rate in nine years. In December, the auto sector jumped 3.7 percent while clothing and accessories were up 4.9 percent.
Bottom line
The key event last week was the Bank of Japan interest rate increase. In the end, equity investors were pleased while currency traders were not. There is relief that the uncertainty is over for a while given the Bank's dovish intention to leave rates where they are at 0.5 percent for some time to come. There was little in new economic data. Earlier flash GDP estimates were confirmed and details showed that consumers did their share in boosting UK GDP while trade contributed to the German recovery. And a second successive decline in Germany's Ifo business sentiment index had only a limited impact primarily because analysts decided it would not affect the European Central Bank's decision to increase rates possibly at its March meeting.
The pace of month-end indicators picks up this week. Most of Japan's major economic data will be issued including its consumer price index, unemployment data and industrial production. No doubt these data will be weighed in conjunction with last week's interest rate move. No major central bank meetings are scheduled for this week, but investors will no doubt be preparing for the following week when there is a full slate of meetings including the Reserve Bank of Australia, Banks of Canada and England and the European Central Bank.
Looking Ahead: February 26 through March 2, 2007
Anne D Picker is the author of International Economic Indicators and Central Banks.
Bank of Japan ends suspense
