Global Markets

Three major central banks met last week and all practiced the fine art of maintaining the integrity of their inflation targets while at the same time hopefully keeping growth on track. As the Reserve Bank of Australia did on Tuesday (local time), the European Central Bank and the Bank of England kept interest rates unchanged on Thursday as they tried to balance the risk of faster inflation against the danger that higher credit costs will drag down economic growth. The three banks maintained their interest rates of 7.25 percent, 4 percent and 5 percent respectively. Soaring food and energy prices are creating inflationary worries as consumer prices soar above established inflation targets. While the RBA published a post-meeting statement and the ECB held its monthly press conference, the Bank of England maintained its silence — it does not issue a post meeting statement when no policy change is made. But it is clear all are worried about inflation and the dim prospects that price increases will ease soon.

Oil prices reached new highs while concerns over slowing growth and a worsening of credit conditions drove investors to seek safe havens. Crude oil’s spike above $126 a barrel prompted heavy equity selling. Stocks were down for the most part last week as growth worries combined with renewed uneasiness about emerging subprime issues resurfaced. A flight to safety followed an announcement from the Securities and Exchange Commission Wednesday that it was scrutinizing investment banks and would urge more transparent disclosure from securities companies.

All Asian/Pacific stocks, with the exception of the All Ordinaries (up 1.5 percent), Jakarta Composite (up 1.4 percent), KLSE Composite (1.1 percent) and SET (up 0.4) were down on the week. The FTSE, CAC and DAX were down as well. In North America, only the Toronto S&P/TSX Composite posted a gain.

Global Stock Market Recap

Europe and the UK

The FTSE, CAC and DAX ended the week on a negative note after subprime woes resurfaced and crude oil prices continued to soar, hurting stocks such as airlines and auto makers. This was the first weekly decline since the week ending April 18. For the FTSE, banks were weaker thanks to lingering fears about the health of the UK mortgage market and the Bank of England left interest rates on hold. Just when investors began to think that the worst of the credit crisis was over, the record quarterly loss and credit-related writedowns from AIG, the world’s largest insurer, undermined sentiment in the financial services sector. Oil companies failed to be boosted by the elevated oil price as fears about the wider impact of record oil prices on the global economy weighed. The CAC and DAX were hit by a broad-based retreat, led by financial, pharmaceutical and energy & mining stocks.

Bank of England on hold at 5 percent

As expected, the Bank of England kept its key interest rate at 5 percent. It lowered its rate by 25 basis points at its April meeting and appeared reluctant to reduce rates two months in a row. The monetary policy committee undoubtedly wanted to emphasize that it is taking inflation threats seriously. Recent comments suggest that a majority of the MPC is committed to a gradual easing of interest rates. Lower rates appear to be a timing issue and not one of direction.

Recent economic data have been weak. For example, the services sector PMI released earlier in the week showed activity falling to its lowest level since March 2003 and a new low was reached in the Nationwide Consumer Confidence Index. And industrial and manufacturing output both declined more than expected in March. However, these data are counterbalanced by continued higher than target inflation. The recent decline in the pound sterling and news on pipeline-pricing pressures are likely to have increased the MPC's anxiety on this front. A new quarterly Inflation Report will be released on Wednesday (May 14) and will give MPC members more solid ground to base policy. The Inflation Report is likely to show that the outlook for inflation and growth has worsened since the February report. The Bank does not issue a statement when no policy change is made.

ECB’s concern is secondary effects

As universally expected, the European Central Bank kept their policy interest rate at 4 percent. The ECB is in neutral and determined above all to keep inflation expectations anchored and not permit second round effects from taking place. Although the HICP eased to an annual increase of 3.3 percent from 3.6 percent in March, it is considerably above the ECB inflation target of 2 percent. And M3 money supply growth is more than double its reference value of 4.5 percent. But there are signs of slower growth. For example, business confidence in Germany, Belgium and France all dropped as did the European Commission’s economic sentiment index. And retail sales have disappointed as well while German orders and industrial production were down for the latest month. This month’s meeting was held in Athens. The ECB’s governing council meets twice a year outside its ‘home town’ of Frankfurt.

In his press conference following the meeting, president Jean Claude Trichet said that the ECB still believed inflation would decelerate — but only gradually — while upside risks prevailed. His remarks suggested governing council members still felt it was too early even to signal the possibility of lower borrowing costs in the pipeline. Reinforcing the impression that the ECB saw no early need to change its monetary policy stance, Mr Trichet acknowledged expectations about future inflation rates were “in line with our mandate”. On growth, Mr Trichet was relatively upbeat despite increasingly gloomy forecasts from international institutions.

Asia/Pacific

Most Asian/Pacific indexes were down last week, buffeted by higher commodity prices especially for food and energy and disappointing earnings reports. Prices continue to rise with crude setting almost daily new highs. And earnings reports such as those from the U.S. insurer AIG — their quarterly loss was bigger than expected —triggered renewed worries of further subprime trouble ahead. Earnings gloom was compounded by earnings reports from Toyota and Olympus who predicted profits would fall as raw material costs rise. On Friday (local time), electronics companies, car makers and banks accounted for nearly half of the fall in the Nikkei. Toyota sank after it said that more expensive fuel, a U.S. economic slowdown and the stronger yen would slow sales and cut annual profits by around a quarter. Shanghai shares followed the regional trend lower. The mood was also nervous ahead of the release of April’s consumer inflation figures for China on Monday. Economists suggest the CPI will probably stay elevated and close to the highest level 11 years. Japanese markets were closed Monday and Tuesday for last of Golden Week holidays.

However, the All Ordinaries bucked the regional trend as one of the country’s biggest banks said profits rose by 26 percent in the first half of the (fiscal) year, and buoyant oil prices drove mining stocks higher. The Reserve Bank of Australia’s forecast of increased inflation and lower growth as consumers cut spending seemed not to worry investors. Employment continued to rise thanks to strong Chinese demand for its commodities.

Reserve Bank of Australia fighting inflation

As expected, the Reserve Bank of Australia kept its key interest rate unchanged at 7.25 percent for the second month. The RBA has been trying to gauge whether their highest interest rate in 12 years is sufficient to slow the economy enough to cool inflation which is at its highest since 1991. The RBA last increased rates in March, which was the fourth time in seven months as the Bank attempted to tamp down inflation which had risen above its inflation target range of 2 percent to 3 percent. Recent data show that both consumer and business confidence have slumped, while retail sales and home building have slowed. First quarter consumer price index was up 4.4 percent when compared with the same quarter a year ago and the highest rate in almost 17 years.

In its quarterly policy statement released Friday (local time) the RBA said it is concerned that inflation will not return to the 2 percent to 3 percent target range until 2010. The RBA lifted its 2008 inflation forecast to 4 percent from 3.5 percent and cut its GDP forecast to 2.25 percent from 3.25 percent. Inflation is expected to continue well into the next two years amid tight credit conditions and slowing global demand. Since May 2002, the RBA has increased interest rates 12 times and had continued to increase rates despite cuts by the Federal Reserve and the Banks of Canada and England.

Bank of Korea also on hold

On Thursday, the Bank of Korea kept its key interest rate steady at 5 percent, the highest in almost seven years. The Bank said that rising commodity prices and a weakening currency are fueling inflation. The country’s annual inflation rate reached a four-year high of 4.1 percent in April, exceeding the central bank’s inflation target range of 2.5 percent to 3.5 percent for the fifth straight month. The Bank of Korea Governor Lee Seong-tae revised his growth forecast down to 4.5 percent or below from an earlier projection of 4.7 percent.

Currencies

The euro, which just last month hit a record high of $1.6018 against the dollar, plunged to a low of $1.5287 on Thursday as a growing feeling emerged that the single currency might have peaked. However, the euro regained its cool and settled around $1.548 at week’s end. The euro’s slide was helped by continued weakness in economic data, which heightened expectations that the European Central Bank might shy away from its hawkish stance on interest rates and signal that it was ready to start cutting interest rates. That of course did not happen after ECB president Jean Claude Trichet stuck to his mantra, reiterating time and again his concerns over rising price pressures and possible secondary effects.

Sterling was down against the dollar as evidence accumulated that the UK economy was suffering from the effects of financial market turbulence. Consumer confidence plunged to a record low, industrial output unexpectedly contracted while the housing market continued to show signs of weakness. Although the pound staged a small recovery after the Bank of England kept interest rates at 5 percent on Thursday, most analysts are expecting the Bank to resume its monetary easing cycle in June, thus keeping the pressure on the pound.

The Canadian dollar was up thanks to a fifth consecutive day of record high oil prices, strong Canadian job growth and an improved merchandise trade surplus. The news pushed the Canadian dollar higher against most major currencies. However, the currency loitered just under parity with the U.S. dollar.

Elsewhere, the yen rallied strongly as a sell-off in equities increased risk aversion and pushed investors towards the safe haven of the low-yielding Japanese currency. The yen was up against most major currencies and moved to multi-week highs against the dollar, euro and pound sterling.

Selected currencies — weekly results

Indicator scoreboard

EMU

March producer price index was up 0.7 percent and 5.7 percent when compared with a year ago as expected. The index was driven higher by a combination of energy and agricultural inputs. Energy, which accounts for 17.6 percent of PPI inputs, delivered the biggest upward push while nondurable consumer goods (which includes processed foods) accounts for 25.7 percent. On the year, energy prices were up 12.7 percent while nondurables were up 5 percent. Excluding energy, the PPI was up 0.3 percent and 3.7 percent on the year. Luxembourg and Greece with PPI increases of 1.3 percent and 1.1 percent respectively recorded the largest increases. They were followed by Belgium, Spain and Portugal all with increases of 0.9 percent on the month.

March retail sales declined 0.4 percent and were 1.6 percent below their year ago level. The latest monthly drop was dominated by the non-food sector (0.6 percent) while food sales slipped only marginally (0.1 percent). However, over the year, the headline decline is led by food (2.7 percent) where the pace of contraction was notably sharper than in the non-food area (0.9 percent). Sales were down in the larger economies with France down 0.7 percent, Spain down 0.4 percent and Germany down 0.1 percent.

Germany

March manufacturers orders were down 0.6 percent but were up 5.1 percent when compared with last year. Domestic orders were down 0.9 percent while foreign orders were down 0.4 percent. The entire drop in the latter was attributable to weakness in the EMU bloc (down 3.5 percent) which was driven lower by a slump in investment goods (down 7.5 percent) and a hefty decline in the consumer sector down 3.6 percent). Together these easily offset a tidy increase in basic orders (3.7 percent). Overall non-EMU orders were up 2.1 percent. Within the domestic arena, the investment sector sank 2.1 percent with consumers down 1.7 percent. Once again, basic goods (0.7 percent) were the sole positive contributor to the headline index.

March industrial production excluding construction — the ECB’s favored measure — edged up 0.2 percent and was up 5.1 percent when compared with last year. However, industrial production including construction dropped 0.5 percent but was up 4.6 percent when compared with last year. The decline in total industrial production was heavily prejudiced by a 12.3 percent slump in the construction sector following a weather-related surge at the start of the year. The highly erratic energy sector bounced 5.5 percent on the month but annual growth was more subdued at 4.9 percent. Amongst the major market sectors, output of basic goods rose a solid 1.1 percent but capital goods contracted 0.8 percent. Consumer nondurables grew 0.7 percent but the durables area was only flat.

March seasonally adjusted merchandise trade surplus narrowed to €15.4 billion from €16.8 billion in February. Exports slipped 0.5 percent while imports were up 0.8 percent. This was the third drop in exports in the last four months. Over the year, total exports were up just 0.2 percent, within which purchases by other eurozone countries fell 2.7 percent. Overall imports on the other hand were up 3.3 percent over the same period, with flows from the other EMU countries rising 0.2 percent. On a non-seasonally adjusted basis, the trade balance narrowed to a surplus of €16.7 billion in March compared to €16.9 billion in February.

France

March merchandise trade gap widened to €4.75 billion. Exports sank 6 percent while imports were down a more modest 0.6 percent. The largest single contribution to the deficit came from basic goods where the shortfall widened out to €1.4 billion from €0.8 billion in mid-quarter. However, there was also a sizeable increase in the red ink on consumer goods while the surplus on food stuffs declined significantly. By region, the bilateral gap with the most important trade partner, Germany, expanded by 6.6 percent and rose by 45.5 percent with Belgium/Luxembourg.

March industrial output excluding construction dropped 0.8 percent and is up 1 percent when compared with last year. Manufacturing output dropped 1.5 percent in March. Although total production was boosted by a 2.4 percent jump in the energy sector all the other categories registered steep declines. Weakness was especially marked in clothing & leather (3.3 percent), household durables (2.4 percent), the auto industry (2.9 percent), electricals (2.7 percent) and minerals (2.8 percent). There were also hefty drops in textiles (2.6 percent) and chemicals, rubber & plastics (2.5 percent). Outside of utilities (3.3 percent), the only other gainers were wood & paper (0.1 percent) and pharmaceuticals (0.4 percent). Production in the construction sector was flat on the month.

United Kingdom

March industrial production declined by 0.5 percent but was up 0.2 percent when compared with last year. The monthly drop was led by electricity, gas & water (1.4 percent) but manufacturing output was also down (0.5 percent). Manufacturing output was up 0.6 percent on the year. Against that, there were increases in output in both mining & quarrying (0.5 percent) and oil & gas extraction (0.6 percent). By market sector, the largest decline was in durable goods (1.3 percent) where output now stands 2.3 percent below its year ago level. Declines in the other areas were less marked, ranging from nondurables (0.1 percent) through capital goods (0.4 percent) to intermediates (0.5 percent). Annual growth in nondurables (0.3 percent) and capital goods (1.3 percent) remains positive but is now negative in the intermediates sector (0.1 percent). In the manufacturing sector, with the exception of coke & petrol (1.2 percent), all of the main output categories were down on the month. Particularly marked declines were recorded by textiles & clothing (0.9 percent), chemicals & fibres (0.7 percent) and other manufacturing (0.8 percent). However, there were also declines in metals (0.6 percent), engineering (0.3 percent) and food & drink (0.2 percent).

Asia/Pacific

Australia

March merchandise trade deficit was A$2,736 million, down from February’s revised deficit of A$3,261 million. The decrease in the deficit was due increased goods and services exports, mainly non-rural and other goods outweighing higher goods and services imports, mainly capital goods and consumption goods. Exports were up 4.4 percent. Non-rural and other goods were up A$657m (5 percent) and rural goods were up A$122 million (6 percent). Services exports climbed by A$36 million (1 percent). The increase in non-rural and other goods was driven by metal ores and minerals, which jumped by A$471million (16 percent) and coal, coke and briquettes, which rose A$341 million (23 percent). Imports were up 1.3 percent. Capital goods imports were up A$156 million (4 percent) while consumption goods were up A$126 million (2 percent). The increase in capital goods was driven by machinery and industrial equipment and rise in consumption goods which was driven by non-industrial transport equipment, mainly passenger motor vehicles.

April employment was up 25,400 jobs after a gain of 18,200 in March. Full time employment was up by 19,000 jobs while part time employment gained 6,300 jobs. The number of unemployed increased by 16,900 to 469,800. The number of persons looking for full-time work increased by 17,300 to 330,500 and the number of persons looking for part-time work decreased by 400 to 139,300. The unemployment rate edged up to 4.2 percent from 4.1 percent in the previous month. The participation rate edged up to 65.4 percent from 65.2 percent in March.

China

April producer prices were up 8.1 percent on the year in April. They were boosted by soaring energy costs to their highest rate since hitting the same mark in November 2004. The PPI was 8.0 percent in March. Through the first four months of the year, producer prices are 7.2 percent higher than over the same period in 2007. In the first quarter, PPI stood at 6.9 percent. Prices for raw materials, fuel & power were up 11.8 percent while production materials prices increased 9.0 percent, mining & exploration prices jumped 27.2 percent and raw materials prices were up 10.4 percent in April. Prices for food & related products jumped 11.9 percent, while clothing & related product prices gained 2.3 percent. Prices of daily consumer goods added 3.7 percent, while consumer durables prices eased by 0.5 percent.

Americas

Canada

April employment was up 19,200 while the unemployment rate edged up to 6.1 percent from 6 percent in March. The increase in employment was fully accounted for by the increase in full time jobs which were up 20,600. However, part time jobs dropped by 1,400. Job creation in April was concentrated in services (22,900) as employment in the goods producing area (down 3,700) posted a mild contraction. Within the former sector, the main impetus came from accommodation & food (22,200) followed by education (13,800) and information, culture & recreation (7,100). However, there were declines in business, building & other support services (11,700) as well as in other services (9,100) and trade (1,200). Among relatively broad-based declines in the goods producing sector, manufacturing (14,900) was the hardest hit ahead of agriculture (5,400) and utilities (1,900). Construction (16,200) benefited from favorable weather and natural resources (2,200) also edged a little firmer.

March merchandise trade surplus climbed to C$5.5 billion, its highest level since May 2007. This was the third month in a row that the surplus has expanded. The black ink with the U.S. rose from C$8.3 billion to C$8.6 billion while the deficit with Japan grew from C$0.1 billion to C$0.2 billion and the shortfall with the EU (C$ 0.1 billion) remained essentially unchanged. Total exports rose 1.6 percent on the month while imports slipped 0.3 percent. Within overall exports, there were strong gains in agriculture & fishing (4.7 percent), energy (6.6 percent) and other consumer goods (13.4 percent), mainly due to the buoyancy of pharmaceuticals. Energy exports cleared the C$10 billion mark for the first time. Against these gains, there were declines in forestry products (7.7 percent) and autos (4.9 percent) with both sectors especially hard hit by both the sluggishness of U.S. demand and labor disruptions across the border. Imports were boosted by a surge in energy goods (17.6 percent) which saw crude petroleum hit yet another new record, but other categories all posted declines. In particular there were significant drops in autos (11.4 percent), other consumer goods (2.5 percent) and forestry products (1.7 percent).

Bottom line

This past week has been dominated by central bank meetings and soaring crude oil prices. Inflationary pressures influenced the decisions of the Reserve Bank of Australia, Bank of England and the European Central Bank as they grappled with evidence of rising prices and slowing growth prospects. Data focused primarily on international trade, with the Canadian surplus rising on demand for commodities while Germany’s surplus edged lower on the back of the higher euro and slower growth among its trading partners.

First quarter gross domestic product data will be released for the EMU, Germany, France and Japan this week. And investors will be watching crude oil to see how high it can go.

Slovakia’s membership in the European Monetary Union was approved. It will become its 16^th member on January 1, 2009.

Looking Ahead: May 12 through May 16, 2008

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