Global Markets

Three central bank announcements and U.S. retail sales and producer price data dominated equity markets late last week. The Banks — the Federal Reserve, Bank of England, European Central Bank — did what was expected. But traders were disappointed by U.S. retail sales data and that in turn negatively affected stocks in countries that rely on exports to the U.S. for profits and growth.

The global equity rally which had been sparked by frantic merger and acquisition activity was offset by profit taking. Trading was volatile day to day as rumors percolated through the markets. After dropping on Thursday, equity traders were distracted Friday when the U.S. producer price report precipitated a rally on signs that U.S. inflationary pressures could be easing and could lead to a rate reduction by the Fed. Eight indexes of those followed here gained on the week. The Hang Seng, STI, CAC, DAX, FTSE and Nasdaq were down on the week.

The Federal Reserve left its target fed funds rate unchanged at 5.25 percent as universally expected by economists. The language in their communiqué was almost unchanged from the one issued at the previous meeting other than acknowledging that economic growth slowed in the first part of the year. However, it was clear that inflation, and not slowing growth, remains the FOMC’s main policy concern. The European Central Bank left its policy rate at 3.75 percent while the Bank of England increased its key lending rate to 5.5 percent.

Global Stock Market Recap

Europe and the UK

Trading in the UK and Europe continues to be dominated by merger and acquisition moves especially in media and metals. The banking sector, however, has been addled by interest rate concerns. On Thursday, investors had ample opportunity to respond to the widely expected decision of the FOMC to leave rates unchanged. As to be expected, analysts focused on the FOMC’s post-meeting statement that was virtually unchanged from the previous one. Markets in Europe were already closed on Wednesday prior to the Fed’s announcement. Traders also had the opportunity to respond to the Bank of England’s rate increase and the ECB’s expected June increase on Thursday as well. All three declined.

European and UK markets rebounded on Friday after a dismal start to trading, thanks in part to a positive boost from U.S. trading. Stocks also gained on takeover speculation in banking and metals; and that gave the CAC, DAX and FTSE reason to rebound. However, it was not enough to offset losses incurred earlier in the week. Earlier in the week, stocks retreated from a 6 1/2-year high on concern higher U.S. import prices and rising interest rates in Europe would cool economic growth.

Bank of England ups interest rates

As widely expected, the Bank of England’s monetary policy committee increased their key interest rate by 25 basis points to a six-year high of 5.5 percent. UK borrowing costs are now the highest among the Group of Seven nations (United States, Canada, UK, Germany, France, Italy and Japan). Analysts however are divided on whether and when another increase might occur. The uncertainty is focused on the impact of monetary tightening on demand and corporate pricing power for the rest of this year and 2008. The pound sterling, which has been flirting with the $2 level, eased after the Bank’s announcement. The March inflation rate which was more than a percentage point above the bank's target, forced governor Mervyn King to write Chancellor Gordon Brown a letter on April 17. It contained assurances that policy makers are determined to quell price increases. His letter to the Treasury was the first since the Bank won independence in 1997. In its announcement, the Bank said it increased rates because “output growth has remained firm. Business investment has been stronger than expected and, although indicators of consumer spending have been volatile, the underlying picture is one of steady growth.”

Thursday’s increase was the fourth since the start of August. Britain's key rate is now higher than the Fed’s 5.25 percent target. The European Central Bank kept its interest rate at 3.75 percent at their meeting on Thursday. Canada's key rate is 4.25 percent and Japan's is 0.5 percent.

European Central Bank uses code word

The European Central Bank left its main interest rate unchanged at 3.75 per cent on Thursday but signaled that a quarter percentage point rise is likely in June. As widely expected, ECB President Jean Claude Trichet pledged “strong vigilance” to keep inflation in check. He has used this phrase in the past to signal each of the Bank’s seven rate increases since the end of 2005. He also said inflation would fall in the short term before rebounding towards the end of the year. The ECB governing council meeting was in Dublin, one of the two meetings a year when it gathers outside its Frankfurt home. Trichet also said interest rates were still moderate and on the accommodative side. Speaking of Thursday’s meeting, he said the decision to keep rates unchanged was unanimous.

The ECB forecasts economic growth of about 2.5 percent this year and 2.4 percent in 2008 after 2.7 percent last year, which was the fastest expansion since the turn of the decade. Some labor unions have already used the pace of growth to push through wage increases. Adding to the ECB's concerns, money-supply growth, which the bank uses as a gauge of future inflation, unexpectedly accelerated in March to the fastest pace in more than 24 years.

Asia/Pacific

Asian/ Pacific equities were mixed last week as they coped with mixed U.S. data along with fluctuating prices for metals and crude. The U.S. economy is the key to exporters’ profitability. When there are signs of weakening growth in the U.S., stocks of exporters usually drop. Missed profits estimates and broker downgrades also weighed on stocks. Asian stocks get support/pressure from overnight trading in U.S. stocks. As evidenced in the graph below, Thursday’s drop in U.S. stocks depressed Asian/Pacific stocks on Friday with the exception of the Kospi.

Toshihiko Fukui, Bank of Japan governor, told the Japanese parliament that keeping rates low could fuel yen carry trades and destabilize the country's economy. Japan's interest rate of 0.5 percent is the lowest among the Group of Seven nations. They are also relatively low in comparison with the economy, which has been growing at a little more than 2 percent in recent years. But at the same time, Fukui sought to counter a growing view that the BoJ may not be able to raise rates soon, which it fears could fuel a real estate bubble and lead to more investors borrowing low-interest yen to invest in higher-yielding assets overseas (carry trade). Fukui gave no indication of how soon the Bank might raise rates but there is a broad consensus that the BoJ would not be able to increase rates until after the July Upper House elections.

Currencies

The euro declined for the second week despite U.S. dollar weakness Friday after retail sales data disappointed and producer prices eased. Friday’s U.S. dollar decline was against most currencies as the data were deemed dovish for future Federal Reserve policy. The euro was down on the week even though an interest rate increase by the ECB is anticipated at their June meeting. The European currency reached the all-time high of $1.3681 on April 27. The euro fell against the dollar on speculation the European Central Bank won't push up borrowing costs as fast as some investors had anticipated after president Trichet declined to give an indication of direction beyond the next meeting in June.

The yen was virtually unchanged on the week but weakened against most other active currencies on speculation investors increased their purchases of higher-yielding assets and financed them by borrowings in Japan (carry trade). Japan's benchmark borrowing cost of 0.5 percent is the lowest among major economies.

Indicator scoreboard

Germany — March manufacturing orders soared 2.4 percent and 13.8 percent when compared with last year. This exceeded all analyst expectations by far — most had expected a decline. Domestic orders were up 2.9 percent and 11.9 percent on the year while foreign orders were up 2.1 percent and 15.7 percent. Capital goods were up 2.9 percent while basic goods were up 2.8 percent on the month. Capital goods were driven by domestic demand while basic goods’ strength was in foreign orders. However, consumer & durable goods orders remained weak, declining 0.7 percent.

March total industrial production slipped 0.1 percent but was up 7.7 percent when compared with last year. Excluding construction, industrial production was up 0.3 percent for the second month and 7 percent on the year. Construction was down 6.5 percent but up 22.2 percent on the year. Manufacturing production was up 0.3 percent and 8.6 percent on the year. Consumer nondurable goods were up 1.4 percent and 1.7 percent on the year while durable goods were down 1.6 percent but up 6.7 percent. Capital goods output was down 0.8 percent and up 9.2 percent on the year.

March merchandise trade surplus climbed to €15.6 billion from €14.7 billion. Exports were down 1.4 percent but imports dropped more, down 3 percent. When compared with March 2006, exports were up 9.3 percent while imports were up 4.6 percent.

France — March merchandise trade deficit eased to €1.65 billion from €2.35 billion the previous month. Exports were up 0.7 percent thanks to sales of two satellites and 26 Airbus planes. Machine tool exports were also positive. Imports dropped 1.4 percent. The volume of crude oil imports declined.

March industrial output edged up 0.2 percent and climbed 1.1 percent when compared with last year. Manufacturing output, however, was down 0.1 percent but was up 1.8 percent on the year. Output eased after a very strong February when industrial output jumped 1.2 percent while manufacturing output jumped 1.5 percent. Auto sector output was down 2.4 percent while semi-finished goods were down 0.2 percent. On the positive side, consumer goods output was up 0.6 percent and capital goods, 0.4 percent. Excluding construction, output was up 0.2 percent and 1.1 percent on the year.

United Kingdom — March global merchandise trade deficit was £7.048 billion, up from February’s deficit of £6.948 billion. Exports were up 5.2 percent while imports increased by 4.2 percent. Global goods and services deficit was £4.529 billion from £4.289 billion in February. The deficit with EU countries increased while the deficit with non-EU countries narrowed slightly.

March industrial production was up 0.3 percent but declined 0.2 percent when compared with last year. Manufacturing output was up 0.6 percent and 0.9 percent on the year. Eleven of 13 manufacturing sectors were up on the month. Mining and quarrying was up by 1.3 percent, a similar rise to that in the utilities sector.

Asia/Pacific

Australia — March retail sales were up 1.1 percent and 7.8 percent when compared with last year. Department store sales were up a vibrant 3.6 percent while recreational goods were up 2.3 percent. Food sales along with household goods and clothing & soft goods sales were all up 0.7 percent.

April employment soared by 49,600 jobs. At the same time the unemployment rate edged down to a 32-year low of 4.4 percent from 4.5 percent in March. The number of full-time jobs increased by 11,600 while part-time employment gained 38,000. About 10.4 million of Australia's 20.8 million people are employed. Job strength has been concentrated in the commodity-impacted sectors of mining, construction & utilities and the public sector. The participation rate, which measures the labor force as a percentage of the population aged over 15, climbed to 64.9 percent.

Americas

Canada — March merchandise trade surplus declined to C$4.6 billion from C$5.2 billion in February. Exports were up 1.4 percent while automotive products gained a robust 7.9 percent. Imports were up 3.3 percent with energy products leading the gains. All but two sectors, forestry products and agricultural & fishing products, registered increases as well. Imports from the United States increased by more than C$1.0 billion to reach a peak of C$23.6 billion, while exports to the U.S. grew just over $300 million to $31.3 billion. In comparison, Canada's imports from countries other than the United States were up by C$136.7 million to C$12.3 billion, while the gain in exports to these destinations climbed to C$9.3 billion.

April employment declined by 5,200 jobs. The unemployment rate remained at its 33-year low of 6.1 percent for the third month. Full time jobs were down by 14,900 while part time jobs were up 9,700. The goods producing sector lost 5,100 jobs as an increase of 11,000 jobs in natural resources did not offset a decline of 19,000 jobs in manufacturing. Jobs declined by 17,000 in finance, insurance, real estate & leasing and in other services.

Bottom line

Inflation and interest rates captured analyst interest last week. The Federal Reserve and European Central Bank did not alter their current interest rates of 5.25 percent and 3.75 percent respectively. The Bank of England increased its key rate to 5.5 percent to reduce inflationary forces that have sent their price measure up by 3.1 percent on the year. Prices in the U.S. eased on the producer level, but retail sales also eased. Merchandise trade data were released by several countries. The U.S. deficit was larger while the Canadian surplus was smaller but Germany's surplus was larger.

The Bank of Japan meets this week. As stated earlier no change in policy is anticipated before the July Upper House elections. The first estimates of first quarter gross domestic product in Europe and Japan along with consumer price data will dominate new economic data.

Looking Ahead: May 14 through May 18, 2007