Global Markets

Thanks to positive performances earlier in the week, most indexes followed here managed to post a rare gain for the week. Positive U.S. retail sales in January helped boost morale (the gain was mostly a gasoline price increase) at least in the short term. And in Asia, morale was boosted by much better than expected Japanese GDP data. GDP grew by 0.9 percent on the quarter or at an annualized rate of 3.7 percent. However, GDP was up only 1.8 percent when compared with the same quarter a year ago. A word of caution is required though — these data are subject to major revisions.

Trading was volatile during the week with large swings during intraday trading as well as from day to day. For example on Tuesday, U.S. and European equity markets experienced violent swings but moved sharply higher after Warren Buffett (the U.S. investor) offered some respite for ailing bond insurers. Investors welcomed the move, hoping that relief in this sector would ease pressure in other areas of the credit market. But some analysts were cautious on the proposal, noting that none of the insurers offered the support had yet accepted. But while momentarily pleased with the offer, investors continued to focus on credit market woes as new problems continue to surface.

On Thursday, investors were depressed even further by a gloomy outlook for the U.S. economy presented to the Senate Banking Committee by Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson. They acknowledged that the outlook for the economy had worsened. Mr. Bernanke signaled that the Fed is ready to reduce interest rates yet again, pointing out that problems in housing and mortgage-related markets have spread more widely and have proven more intractable than he predicted three months ago. His sobering assessment was echoed by Mr. Paulson. Both continued to avoid predicting a recession but said they were scaling back the more optimistic forecasts they had issued in November.

Global Stock Market Recap

Europe and the UK

Despite erratic swings from day to day, the CAC, DAX and FTSE were up on the week. They continued to follow U.S. trading patterns at least in their afternoon trading sessions. Positive mornings have often led to reversals once the U.S. trading day began. For example, European stocks were up Thursday morning on positive earnings news but soon lost these gains after the Bernanke/Paulson testimony to Congress. Fears of contagion escalated on mounting speculation that banks would post more losses and the U.S. economy would slip into recession. The latter fear was underlined by a report that showed New York manufacturing contracted and import prices were up more than anticipated by analysts. And although banks have made progress in credit market related write downs, they remain at risk now because of the bond insurance or monoline crisis. Investors dislike uncertainty. And again fears of the unknown are rattling investors.

Bank of England’s quarterly Inflation Report

The Bank of England released its quarterly Inflation Report on Wednesday. In a hawkish report, the Bank said that interest rates are unlikely to fall as much as markets expect to stem the economic slowdown. In its quarterly update on the outlook for the UK economy, the Bank predicted that tighter credit conditions, constraining both investment and consumer demand, could lead to a “deeper and more persistent” slowdown than it expected in November. However, rising food, energy and import prices are likely to push inflation sharply above target in the short term, whatever the path of interest rates. The Bank is mandated to keep consumer price increases at about 2 percent in the medium term. If the key interest rate remains at its current 5.25 percent, inflation would be below the 2 percent level in two years. However, if rates were cut to 4.5 percent as anticipated by the markets, inflation would be above the 2 percent target.

Asia/Pacific

Asian/Pacific stocks ended last week on a mixed note with overall sentiment remaining sluggish on worries of world economic growth. While several of the indexes followed here managed to gain on the week, the All Ordinaries, Kospi and Shanghai Composite were the exceptions and lost ground. The Shanghai Composite, which had been closed for the Lunar New Year celebrations, declined on two of its three trading days in thin trading. The index is down 14.5 percent in 2008.

After six losing weeks, the Nikkei advanced for the first week this year — the index was up 4.7 percent — but remains 11.0 percent below its end of 2007 level. Stocks in the region all rallied on the much better than expected Japanese fourth quarter gross domestic product numbers Thursday. Asian stocks jumped, led by the biggest gain in the Nikkei since 2002 as the economy grew twice as fast as estimated and U.S. retail sales unexpectedly registered an increase.

Asian shares started broadly higher Wednesday as regional markets echoed gains in the U.S. from Warren Buffett’s proposal to help bond insurers, but the gains were erased later as investors could not shake off persistent concerns over the health of the banking systems in the U.S. and Europe. And worries resurfaced Thursday after Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson's comments to the Senate Banking Committee. Their comments suggested a slowing pace of economic growth.

The Kospi inched down on the week as concerns over the ongoing uncertainty weighed on investor sentiment. Traders said that the market was prone to fluctuations based on emerging overseas news and was down on continuing U.S. economic woes. However, the Hang Seng closed higher on the week for the first time since the first week of 2008. The index managed to recoup all of the previous week’s losses but remains 13.2 percent lower in 2008.

Australian stocks have taken a hit in 2008 as global credit woes and slowing U.S. economic growth weigh on investor sentiment despite favorable national economic news regarding employment, which once again exceeded analysts’ estimates. At the close, the All Ordinaries lost 0.8 percent on the week. The index has lost ground in 2008 with the exception of the week ending January 28. The index is down 11.5 percent in 2008.

Bank of Japan maintains its 0.5 percent interest rate

As expected, the Bank of Japan kept its key interest rate at 0.5 percent where it has been since February 2007. The rate is the lowest among major economies. Recent reports on industrial production and machinery orders show a weakening economy. First estimates of fourth quarter GDP surprised, however. The economy grew at a 0.9 percent rate when compared with the previous quarter and a faster rate than that of the U.S. and EMU. A cautionary note, these data are subject to extensive revision. But the faster than anticipated growth should quash ideas that the BoJ might lower the already very low rate to stimulate growth.

This policy meeting was the second to last under Governor Toshihiko Fukui, whose five year term expires on March 19. Fukui raised the key interest rate in July 2006 for the first time in more than five years, from near zero to reflect the economy's recovery from three recessions since the early 1990s. The governor has said over the past two years that borrowing costs need to be raised gradually to prevent excessive investment. Deputy Governor Toshiro Muto, whose term also ends next month, is the favorite to succeed Fukui. Two deputy governors will be nominated at the same time as Mr. Fukui's proposed replacement is named.

Currencies

The euro was up on the week against the U.S. dollar as weak U.S. data added to concerns that the economy was grinding to a halt. Renewed downward pressure on the dollar occurred after Fed Chairman Bernanke’s testimony on Thursday as market players bet that the Fed would cut its key fed funds rate vigorously when they meet in March. The yen was down after the Bank of Japan left its key interest rate at 0.5 percent and governor Fukui said that inflationary pressures are low.

The Australian dollar or aussie was the biggest gainer versus the U.S. dollar among the 16 most-active currencies after the Reserve Bank of Australia signaled it would increase interest rates again next month after the employment report revealed that labor markets remain tight with the unemployment rate at its lowest since 1974. The RBA increased its interest rate to 7 percent at its meeting earlier this month.

Indicator scoreboard

EMU

December industrial production was down 0.2 percent and up 1.4 percent when compared with last year. Only the energy (0.5 percent) and the intermediate sector (0.3 percent) managed to produce more than in the previous month while there were declines in both capital goods (1.0 percent) and non-durable consumer goods (0.1 percent). Durable consumer goods output was unchanged. Declines occurred in Italy (0.5 percent) although this may have reflected knock-on effects from the November transport strike, followed by Spain (0.2 percent). Germany (0.7 percent) and France (0.7 percent) both posted solid gains although each followed a drop in production in mid-quarter.

Fourth quarter gross domestic product expanded 0.4 percent, down from 0.8 percent in the previous period. On the year, GDP growth slowed to 2.3 percent, down from 2.7 percent in the third quarter. As with most flash estimates, no details were available.

Germany

February ZEW survey of economic sentiment improved to minus 39.5 from minus 41.6 in the previous month. The current conditions slumped nearly 23 points to 33.7, its weakest reading since August 2006 (33.6). The improvement in economic expectations was the first since May 2007. Three-hundred-fourteen analysts and institutional investors participated in the survey which is conducted on a monthly basis by the Centre for European Economic Research (ZEW), Mannheim. The participants were asked from January 28 to February 11, 2008 about their medium-term expectations concerning economic activity and capital markets.

Fourth quarter gross domestic product growth expanded by a sluggish 0.3 percent, down from 0.7 percent in the previous period. On the year, GDP was up 1.8 percent. No details were available in the flash estimate. The first full set of data will be published on February 26.

France

December industrial production excluding construction was up 0.7 percent and was up 1.2 percent when compared with last year. Manufacturing was up 0.3 percent and 0.8 percent on the year. The monthly advance was driven by food & agriculture (1.9 percent), autos (3.5 percent), chemicals (1.3 percent) and energy (1.4 percent). The only major category to see a decline was consumer goods (0.4 percent) which were hit particularly hard by a sharp drop in clothing (1.9 percent).

Fourth quarter gross domestic product growth slowed to 0.3 percent from 0.8 percent in the third quarter. When compared with the same quarter a year ago, GDP was up 2.1 percent, slightly lower than the 2.2 percent rate of the third quarter. The main drivers were gross fixed capital formation (1.0 percent) which saw solid advances in business, household and public administration, and to a lesser extent household consumption (0.4 percent) where growth halved from the third quarter. Public spending was almost flat (0.1 percent) while a larger fall in imports (1.4 percent) than in exports (0.6 percent) ensured a positive contribution from net exports (0.2 percent).

Italy

December industrial production excluding construction declined 0.5 percent and sank 6.5 percent when compared with last year. This was the steepest annual decline since December 2001 (6.9 percent). The monthly drop was the fourth in a row and followed larger revised declines in both October (0.7 percent) and November (1.1 percent). Weakness was broad-based with declines in all of the major categories. Leading the way was capital goods (2.3 percent) with consumer goods (1.4 percent) close behind and then energy (0.5 percent) and intermediates (0.3 percent). Within the consumer sector, the durables production has contracted every month since September, while non-durables have fallen in two of the last four.

United Kingdom

December global merchandise trade deficit narrowed to £7.6 billion as exports slipped 1 percent and imports dropped 2 percent. The latest red ink followed a larger revised shortfall of £7.9 billion in November and masked a deterioration in trade excluding oil and erratics where the deficit widened to £7.8B from £7.1B. The December bilateral goods shortfall with non-EU countries narrowed to £4.1b from £4.4B while the red ink with the rest of the world was essentially unchanged at £3.5B.

January producer output prices or factory gate prices soared 1.0 percent and were up 5.7 percent when compared with last year — its fastest pace since July. The unexpectedly sharp gain was reflected in the core index also which climbed 0.8 percent on the month to lift annual inflation excluding food, drink, tobacco & petrol to 3.2 percent from 2.8 percent at the end of 2007. There were sizeable monthly gains in most sectors with chemical products up 2.1 percent and other manufactures up 2.3 percent. Input prices soared 2.6 percent and were up 19.1 percent on the year and the highest since records began more than 20 years ago. The bulk of the increase was caused by higher food (5.5 percent) and oil prices (4.7 percent). On the year, crude oil was up 70.3 percent while home food materials were up 36.0 percent.

January consumer price index sank 0.7 percent but was up 2.2 percent when compared with last year. Core CPI dropped 1.0 percent and was up 1.3 percent on the year. The formerly targeted RPIX was up 3.4 percent on the year and the annual change in the RPI, upon which many wage settlements are still based, was up 4.1 percent. The main downside pressures on the annual rate came from alcoholic beverages and tobacco, clothing & footwear and miscellaneous goods and services. The main upward pressures were in food & non-alcoholic beverages, furniture & household equipment and transport.

Average earnings for the three month to December were up 3.8 percent when compared to the same three months a year earlier. December average earnings were up 3.6 percent on the year. Excluding bonuses earnings were up by 3.7 percent on the year. Service sector earnings were up 3.9 percent while manufacturing earnings were up 3.5 percent. Private sector earnings were up 4.0 percent.

Unemployment according to the ILO measure dropped 61,000 over the three months to December. This was the largest drop since the November to January 2003 period and of sufficient magnitude to reduce the jobless rate to a lower than anticipated 5.2 percent. At the same time, employment rose 175,000 in the largest quarterly gain since January to March 1997. January claimant count unemployment dropped 10,800 in January. The claimant count unemployment rate remained at 2.5 percent for the fourth month. Joblessness is down 128,500 on the year with the unemployment rate down 0.4 percentage points.

Asia/Pacific

Australia

January employment was up for a record 15^th month, adding 26,800 after adding an upwardly revised 24,800 in December thereby worsening a labor shortage that is stoking inflation and may force the Reserve Bank of Australia to raise borrowing costs again as soon as next month. The unemployment rate dropped to 4.1 percent, the lowest since 1974, from 4.2 percent in December. Full time employment was down by 7,800 but part time employment increased by 34,600. Unemployment declined by 13,900. The number of persons looking for full time work decreased by 27,500 and the number of persons looking for part time work increased by 13,600 to 161,600. However, the participation rate remained steady at 65.2 percent.

Japan

January corporate goods price index was up 0.2 percent and 3.0 percent when compared with last year. Manufacturing product prices were up 0.2 percent for the second month and 2.9 percent on the year. Among manufactured products, prices for processed foodstuffs were up 0.2 percent and 1.8 percent on the year. Prices for petroleum & coal products were up a modest 0.3 percent on the month but soared 26.7 percent on the year. But prices for lumber & wood products dropped 0.9 percent on the month and 1.5 percent on the year reflecting in part the softness in the housing sector.

Fourth quarter preliminary gross domestic product was up a greater than expected 0.9 percent and 1.8 percent when compared with the same quarter a year ago. Fourth quarter GDP grew at an annualized rate of 3.7 percent. Third quarter GDP was revised downward to 0.3 percent on the quarter and 1.3 percent annualized rate. The GDP price deflator which many politicians think should be used to determine the end of deflation was down 1.3 percent on the year after declining 0.7 percent in the third quarter. Private nonresidential investment or CAPEX was up 2.9 percent or at an annualized rate of 12.1 percent. However private residential investment was down for the fourth quarter in a row. Private spending remained weak, climbing by 0.2 percent on the quarter. Overall, the data were better than expected. The expansion that began in 2002 continues.

Americas

Canada

December merchandise trade surplus shrank to C$2.4 billion, its lowest level in some nine years. For calendar 2007, exports and imports both hit record highs as the black ink shrank to C$49.7 billion, down about 3 percent from 2006. Significantly within total exports, the U.S. share fell from 79.2 percent in 2006 to 76.4 percent in 2007. Nominal exports sank a hefty 3.1 percent on the month but in volume terms the decline was even steeper at some 6.5 percent. The value of imports on the other hand edged up 0.7 percent but with prices climbing sharply, they declined also, down 2.7 percent in real terms. Within total nominal exports, the only sector to register a rise was energy products (4.4 percent) but this was easily swamped by the effects of broad-based declines elsewhere. There were particularly large drops in industrial goods and materials (6.5 percent), automotive products (8.7 percent) and machinery and equipment (4.6 percent). The forestry sector similarly saw exports tumble (2.1 percent) with agriculture and fishing not far behind (1.3 percent). Imports were supported by most sectors but energy (19.4 percent) was especially robust, reaching a new record high at C$3.7 billion. Machinery and equipment (1.6 percent) halted a four-month decline and agriculture and fishing (1.0 percent) also saw new highs. However, there were modest declines in automotive products (9.1 percent) and industrial goods and materials (0.8 percent).

December factory shipments tumbled 3.4 percent and were down 6.4 percent when compared with last year. Some 16 of the 21 manufacturing industries posted declines in December. Longer than normal shutdowns at several motor vehicle plants were the primary source of the deep cut in sales. Excluding this sector, orders were off 0.8 percent. The slump in sales saw the inventory/sales ratio jump to 1.33 months from 1.29 in November, the highest level since October 2006 (1.36).

Bottom line

Last week, the first estimates of gross domestic product were released for the eurozone and many of the member states. Growth rates declined in France, Germany and for all the EMU. However, the Japanese economy surprised analysts with a much higher than expected rate of growth.

This week promises to be quiet with little new economic data. Of note are retail sales data for France and the UK. On this side of the pond, both Canada and the U.S. will release inflation data for January. And in the U.S. the main barometer of the housing sector — housing starts — will be released. Analysts will be looking for stabilization in this all important sector — something made more difficult by weather conditions nationwide. And the FOMC minutes will tell us what transpired during the January meeting.

Looking Ahead: February 18 through February 22, 2008

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