Central Banks dominate news
By Anne D. Picker, Chief Economist, Econoday
Friday, December 7, 2007

Global Markets

Last week’s central bank announcements combined with expectations for the Federal Reserve this week dominated news. Of the four major banks that announced decisions during the week, the Bank of Canada and Bank of England announced 25 basis point interest rate cuts — to 4.25 percent and 5.5 percent respectively. The Reserve Bank of Australia and European Central Bank maintained their key interest rates at 6.75 percent and 4 percent. With the usual need for greater liquidity at year’s end combining with the fallout from the subprime mess, the banks have been actively trying to ease the flow.

Early in the week persistent worries about tight credit conditions prompted a bout of risk aversion in financial markets again. Deepening concerns about the impact of the credit squeeze on the global economy provoked investors into selling risky assets. Equities retreated after the previous week’s strong rally, while a further unwinding of risky currency trades drove the low-yielding Japanese yen higher. The nervous mood in the markets was exacerbated by uncertainty about the upcoming interest rate decisions and the U.S. employment situation data on Friday. At week’s end a more positive mood prevailed in the financial markets thanks to reassuring U.S. employment data, an agreement to freeze interest rates on some subprime mortgages and the UK and Canadian interest rate cuts.

Global equities enjoyed a second successive week of gains. The increases ranged from 4.5 percent for the Shanghai Composite to 0.7 percent for the Hang Seng.

Global Stock Market Recap

Europe and the UK

Despite the negative start to the week, the FTSE, DAX and CAC were up for a second consecutive week. Stocks were up at week’s end thanks in part to the proposed rescue plan for troubled U.S. mortgage borrowers. The DAX broke through the key 8,000 level in Friday morning trade but closed just below that level. The DAX has outperformed its European peers during 2007 even though some analysts think the market is most vulnerable to any downward revisions in GDP and would be hit badly under a hard-landing scenario. On Thursday, trading was choppy as investors awaited the Bank of England and ECB decisions. And even after the decisions were announced, traders remained wary. But on Friday, stocks rallied. In London, stocks gained, driven by possible merger news while higher metal prices helped mining companies advance. Beleaguered house builders benefited from a bullish statement on the UK property market. Stocks in Europe were helped by the better than forecast employment gain in the U.S.

Bank of England cuts interest rate

The Bank of England lowered its key interest rate by 25 basis points to 5.5 percent. Its rate, however, remains the highest among G7 countries. Although third quarter growth was robust, recent data have indicated that the economy may be slowing faster than anticipated as a combination of past rate increases take hold and the global credit crunch shows signs of impacting key sectors of the economy. In cutting its rate, the monetary policy committee decided the risks of slowing economic activity outweighed those of increasing inflationary pressures. The Bank has an inflation target of 2 percent and consumer price inflation was above that level in October. Most analysts thought the MPC would wait for firmer evidence of a slowdown, but recent survey data indicated that the important service sector was softening and house prices were declining. By cutting rates, the MPC is trying to preempt a sharp slowdown in output growth rather than focusing higher oil and fuel prices.

ECB stands pat

As expected, the European Central Bank left its key interest rate at 4 percent. The ECB continues to be squeezed between accelerating inflation and weakening growth. November flash harmonized consumer price index was up by a torrid 3 percent when compared with a year ago and was far above the ECB inflation target of less than 2 percent. At the same time, recent economic data suggest that the EMU economy will not escape the ravages of recent financial market turmoil. ECB officials have argued that more time is needed to assess the macroeconomic impact of the global credit squeeze.

At his monthly press conference ECB President Jean Claude Trichet repeated that the Bank is ready to counter upside risks to price stability by acting in a firm and timely manner. He also said that the ECB is monitoring developments very closely and is determined to anchor inflation expectations. He is expected to balance these statements by stressing the uncertainty facing the economic outlook due to the ongoing financial market turmoil and conceding that downside risks to growth persist. Mr. Trichet also said inflation was the sole “needle in our compass,” emphasizing the ECB’s determination not to use its interest rate policy to bail out financial markets.

Asia/Pacific

The seven Asian stock indexes followed here were up last week after getting off to a sluggish start. Like those in Europe and the UK, it was the second weekly gain. The gain was triggered in part by the U.S. government plan to limit defaults on subprime mortgages. On Friday, however, stocks were mixed as profit taking took the Kospi and Hang Seng down for the day. The relief plan suggested three ways to help the beleaguered homeowners by refinancing into a new private loan, moving into a Federal Housing Authority-Secure loan or by freezing their rate for five years. The president said an estimated 1.2 million homeowners could be eligible for assistance under the plan over the next couple of years.

The Nikkei index climbed to a new one-month closing high near the threshold of 16,000 thanks to the carryover from U.S. markets the night before and despite the downward revision in third quarter gross domestic product. The Nikkei has gained over 1,000 points in the last two weeks. Exporter shares benefited from an advancing the U.S. dollar and on Friday, a plan to freeze mortgage rates in the United States which encouraged investors to buy export-oriented issues.

South Korean stocks, although up on the week, ended sharply lower on profit taking Friday. The Bank of Korea’s hawkish outlook was another factor that dented investors’ interest. As widely expected, the Monetary Policy Committee of the Bank of Korea decided to maintain its key interest rate target at its current level of 5.0 percent. The central bank's statement hinted of a possible interest rate increase in the future, as soaring global oil prices threaten to increase inflationary pressures. The central bank has an inflation target of 2.5 percent to-3.5 percent.

Although the Hang Seng was up for the week, stocks were down on Friday thanks to profit taking after seven positive days. There also was an underlying weekend caution after the Chinese government announced earlier in the week that it decided to apply a tightening monetary policy next year. Friday was the last trading session before an index reweighting and the entry of three new stocks to the index. Changes to the Hang Seng, effective after market Friday’s close, prompted funds that mirror the benchmark.

RBA keeps rate at 6.75 percent

As expected, the Reserve Bank of Australia kept its key interest rate at 6.75 percent. The RBA had previously increased rates by a quarter point in both August and November. Australia has so far weathered the U.S. slowdown and financial market turmoil as consumers keep spending and exporters sell more goods to China and Europe. However analysts expect that accelerating inflation, driven by the lowest jobless rate in 33 years and rising wages, may force the Bank to increase rates again as soon as their first meeting in 2008 in February.

RBA Governor Glenn Stevens announced a change in the way the Bank will communicate its policies to the public. They will now issue a statement at the end of each meeting rather than only when there is a policy change. They will make their decision public immediately after the meeting rather than waiting until the next day. And finally, they will release minutes of the Monetary Policy Board two weeks after each meeting. Minutes were released for the November meeting at the time of this announcement.

Canada

The Bank of Canada unexpectedly lowered its key interest rate by a quarter point to 4.25 percent Tuesday in what many analysts described as a defensive move. The Bank ― with an inflation target range between 1 percent and 3 percent ― focuses on the midpoint of 2 percent. In explaining the decision, the Bank said it expects inflation to be lower than initially projected. The statement also cited current financial market difficulties and an increased risk to exports. The decision temporarily put Canadian interest rates below those in the U.S. (at least until Tuesday).

The Canadian dollar dropped after the decision was announced. Bank governor David Dodge has been concerned that the Canadian dollar’s surge in value to a record high is making the country’s products uncompetitive. The trade surplus narrowed to a nine-year low of C$2.7 billion in September — the same month the currency reached parity with the U.S. dollar for the first time since 1976. Canada's currency started rising after hitting a record low in 2002. Since reaching an all-time high of 90.58 Canadian cents per U.S. dollar on November 7, it has weakened to about parity. However, the soaring dollar is hurting many businesses including the powerful lumber and paper industries. A fallout from its high value against its U.S. counterpart is that retail shoppers are swarming to the U.S. to shop, hurting retail sales in Canada. One-day cross border trips are up close to 8 percent when compared with a year earlier.

Currencies

When equities rise, the yen generally declines and did so this week as speculators drifted back into yield based positions. Carry trade — where funds are borrowed cheaply in low-yielding currencies like the yen to purchase higher yielding assets — had been abandoned briefly in the run up to this week’s interest rate meetings in the UK, Europe, Australia and New Zealand. The Bank of Japan's benchmark rate is 0.5 percent, the lowest among industrialized nations compared with 6.75 percent in Australia and 8.25 percent in New Zealand.

The euro was up only marginally despite the hawkish comments in his post-meeting press conference by ECB President Jean Claude Trichet. The euro was up against the dollar after the European Central Bank kept borrowing costs at 4 percent yesterday. Policy makers signaled they were concerned about inflation.

Indicator scoreboard

EMU — October unemployment rate edged down to a new record low of 7.2 percent. Among major countries there were declines in France, Germany and Spain (all to 8.1 percent from 8.2 percent). The lowest rate was in the Netherlands (unchanged at 3.1 percent).

October producer prices (excluding construction) jumped 0.6 percent and were up 3.3 percent when compared with last year. Excluding energy, which jumped another 1.7 percent for a 4.0 percent annual increase, prices were up 0.4 percent on the month and were unchanged at 3.1 percent on the year. Nondurable consumer goods, driven by higher food costs, were up 0.6 percent. Other categories posted significantly more moderate advances with capital goods and durable consumer goods both up just 0.1 percent on the month and 1.5 percent 1.8 percent respectively on the year. Intermediates rose 0.3 percent versus September for an annual gain of 4.0 percent.

October retail sales sank 0.7 percent and edged up 0.2 percent when compared with last year. The bulk of the decline occurred in the non-food sector where a sharp 1.1 percent drop easily wiped out a modest 0.2 percent in September. Annual growth in this area is now a minimal 0.1 percent. Food, drink and tobacco sales were off a more modest 0.2 percent and rose 0.6 percent from October 2006. Data on the individual member countries are limited but key to the overall drop was Germany — down 3.3 percent on the month. Declines also occurred in Denmark (3.0 percent), Belgium (2.2 percent) and Portugal (0.5 percent), Finland (0.5 percent) and Spain (0.3 percent) similarly in negative territory.

Germany — October manufacturers’ orders rebounded gaining 4.0 percent after sinking a revised 1.6 percent in September. Orders are up 10.3 percent when compared with last year. However, the latest monthly jump was heavily biased by an erratic surge in capital goods (8.1 percent) which easily offset declines in both basic goods (0.4 percent) and, potentially more significantly, consumer and durable goods (0.8 percent). Domestic orders rose 2.7 percent, again largely due to capital goods (6.4 percent) but the largest gains were in the foreign sector (5.0 percent) where capital goods soared 9.2 percent on the back of a near 10 percent jump in bulk order demand from the Eurozone.

October industrial production declined 0.3 percent but was up 6.3 percent when compared with last year. Manufacturing edged 0.1 percent higher from September but was offset by a sharp decline in energy production (3.6 percent) and less marked declines in consumer goods (1.3 percent) and intermediate goods (1.0 percent). Capital goods, however, soared 2.1 percent and following the remarkable 8.1 percent monthly leap in orders for this sector in October, further solid gains here seem probable over coming months. Both consumer durable goods and nondurable goods were down 3.5 percent and 0.8 percent respectively.

France — October producer prices were up 0.6 percent and 3.3 percent when compared with last year. The culprits behind the acceleration were food and energy, without which prices were actually very well behaved with monthly and annual changes of 0 percent and 1.8 percent respectively. Among the major components, the steepest single monthly gains were in energy (2.3 percent) followed by agriculture and food (1.2 percent). More significantly, prices for consumer goods and intermediate goods were both flat while capital goods only edged up 0.1 percent.

October merchandise trade deficit expanded to €3.6 billion from €3.2 billion in September. The data extend a gradually deteriorating trend, reflected in red ink of some €29.8 billion over the first 10 months of the year, up 30 percent from the same period of 2006. As usual, dominating the regional shortfall within Europe was Germany where the bilateral deficit edged higher and more than accounted for the entire red ink with the other EMU countries. Elsewhere, net exports to the U.S. were in broad balance but remained in large to deficit to Asia.

Italy — Third quarter gross domestic product was up an unrevised 0.4 percent and 1.9 percent when compared with the same quarter a year ago. Private consumption and government spending both expanded by a sluggish 0.2 percent but capital investment was up by a healthy 1.5 percent thanks to a 2.0 percent jump in machinery and 1.4 percent rise in construction. The international trade sector was a significant negative as a 2.4 percent increase in imports easily outweighed a modest 0.9 percent advance in exports. The GDP deflator eased a little from its second quarter pace (0.7 percent) with a 0.6 percent increase on the quarter although this still lifted the annual growth rate in prices to 2.6 percent.

United Kingdom — October industrial output was up 0.4 percent and 1.0 percent when compared with the same month a year ago. The increase was helped by an erratic 3.3 percent jump in oil and gas sector output. Manufacturing output was up 0.3 percent both on the month and on the year. Mining & quarrying were up 2.5 percent while electricity, gas & water fell 0.1 percent. The performance among the various market sectors was mixed with the most significant advance posted by capital goods (0.8 percent). Intermediates increased by 0.6 percent and non-durable goods edged up 0.2 percent.  However, durables slumped 1.7 percent and now stand some 3.7 percent below their year ago level. In manufacturing, nine of 13 sub-sectors were up with transport equipment notably firm (1.2 percent) courtesy of a 4.7 percent jump in production in the aircraft industry. However, the other four sub-sectors posted declines.

Asia/Pacific

Japan — Third quarter gross domestic product was revised downward to an increase of 0.4 percent from the original estimate of 0.6 percent. On the year, GDP was up 1.9 percent, revised down from 2.1 percent. GDP grew at an annualized rate of 1.5 percent, down from the original 2.6 percent. Private nonresidential investment also was revised downward, from 1.7 percent to 1.1 percent. Private residential investment was marginally revised downward to minus 7.9 percent from minus 7.8 percent. Third quarter private consumption was unrevised at 0.3 percent. The economy continues to struggle on the domestic side, with domestic demand revised to a drop of 0.1 percent from an initially reported gain of 0.2 percent. The GDP deflator was down 0.4 percent.

Australia — October merchandise trade deficit widened to A$2,983 million from A$1,916 million in September. Exports dropped 3.4 percent while imports were up 2.3 percent. Higher oil prices and the impact of the firm Australian dollar lifted the trade deficit to a 17-month high. Rural goods exports dropped 5 percent while non-rural goods exports sank 7 percent. Also contributing to the decline were metal ores and minerals, down 20 percent, metals excluding non-monetary goods were down 22 percent and coal, coke and briquettes down 11 percent. The declines were partially offset by other mineral fuels, up 43 percent and other non-rural products, up 7 percent. However, services exports were up 1 percent with travel services up 1 percent and other services up 2 percent. On the import side, intermediate and other merchandise goods imports were up 6 percent while other goods were up 37 percent. Offsetting these gains were declines in capital goods and consumption goods, down 5 percent and 1 percent respectively.

October retail sales slowed to an increase of 0.2 percent after climbing a revised 0.7 percent in September. Retail sales were up 7.4 percent when compared with the same month a year ago. Sales were mixed with food, household goods and hospitality & services sales declining. However, clothing & soft goods sales were up 2.7 percent while recreational goods soared 7 percent as summer arrived in Australia.

Third quarter gross domestic product was up 1.0 percent on the quarter and 4.3 percent when compared with the same quarter a year ago. Consumption continues to be a main driver for growth, increasing 1.2 percent on the quarter and 3.7 percent on the year. Household expenditures were up 1.2 percent and 4.5 percent on the year and continue to be underpinned by the very strong labor market. However gross fixed capital formation edged down 0.3 percent on the quarter but is still 10.6 percent higher than the same quarter a year ago. Business investment edged up 0.2 percent but was up 12.9 percent on the year.

Americas

Canada — November employment was up 42,600. Full-time jobs rose just over 27,000 and part-time jobs more than 15,000. The unemployment rate edged up 0.1 percent to 5.9 percent from the 33-year low established in October but this reflected more workers entering the labor force. The private sector (49,000) accounted for all of the increase. Outside of manufacturing (down another 16,000) private sector gains were relatively broad-based. In particular there were solid advances in transportation & warehousing (17,000), business building & other support services (15,000), educational services (14,000) and natural resources (6,000).

Bottom line

Two of the four major central banks meeting last week lowered interest rates while two maintained the status quo. The Banks of Canada and England each lowered their key interest rates by 25 basis points to 4.25 percent and 5.5 percent respectively. The Reserve Bank of Australia and the European Central Bank maintained their policy rates at 6.75 percent and 4.0 percent respectively.

This week is highlighted by the FOMC meeting in the U.S. Until recently, most analysts thought that the Fed would leave its fed funds rate at 4.5 percent. Now the betting is that they will lower rates by at least a quarter of a percent and perhaps even a half of a percent.

Looking Ahead: December 10 through December 14, 2007

Anne D Picker is the author of International Economic Indicators and Central Banks.