Global Markets

It was a volatile week in the financial markets as discussion of inflationary pressures ratcheted up thanks to comments and actions by central bankers worldwide. Central bank leaders from the U.S., Europe and Asia voiced their concerns about inflationary pressures last week in both speeches and in bank meeting announcement statements. In Asia, central banks in Indonesia and the Philippines joined the central banks of Vietnam and Pakistan in raising borrowing costs to fend off surging prices especially for fuel and food. And India and Malaysia are expected to follow after their governments today increased gasoline prices to stem crippling subsidy costs. In many Asian countries, fuel costs have been defrayed by government subsidies to lower the cost to consumers.

At a conference organized by the International Monetary Committee Tuesday, Fed chairman Ben Bernanke, European Central Bank president Jean Claude Trichet and Bank of Japan governor Masaaki Shirakawa agreed that persistent inflation pressures were one of the risks being faced by central banks. But what the markets really picked up on was his remarks on the value of the dollar. He said that the Fed was being attentive to the implications of changes in the value of the dollar for inflation and inflation expectations. Bernanke said the Fed has cut rates "substantially and proactively" and that the Fed's commitment to its dual mandate — supporting growth and containing inflation — will be key to ensuring that the U.S. dollar remains strong and stable. Bernanke explained that inflation is high, but noted the pass-through of costs to labor and products has so far been limited. The dollar rallied on Bernanke’s comments against the euro and yen and commodity prices dropped. However, this proved to be a short term move as Trichet’s hawkish post ECB governing council meeting trumped Bernanke’s Tuesday comments. Trichet's remarks including an allusion to a possible interest rate increase (as soon as July) reversed the dollar’s momentum and the euro rose as did commodity prices.

On the week, all stock indexes declined except the Nikkei, Topix and Taiex in Asia and the S&P/TSX Composite in North America.

Crude soars — again

Crude oil roared to a new record on Friday. Prices soared for several reasons — the declining dollar against the euro after the ECB suggested it might increase interest rates, heightened rhetoric in the Middle East against Iran, technical buying as hedge funds that had bet on a decline in crude prices were forced to exit their short positions and Chinese shortages. Crude had been under selling pressure early in the week amid concerns about future Asian demand as governments across the region began cutting fuel subsidies to alleviate strains on public finances. Robust Asian demand has been a key driver of rising oil prices, so the prospect that a reduction in subsidies that could weaken consumption prompted some hedge funds to bet oil prices would fall. However, they were forced to buy back these positions after oil prices reversed direction sharply on Thursday as the dollar weakened and the euro strengthened following the ECB’s explicit signal that eurozone rates were likely to rise in July.

Global Stock Market Recap

Europe and the UK

The FTSE, CAC and DAX were down last week. For the FTSE it was the third weekly decline in a row. On Friday, early positive trading thanks to resource stocks quickly turned negative after poor U.S. employment situation data were released. Resource stocks gained on higher commodity prices but these gains were offset by declining bank shares as concerns over economic growth loomed large. Oil prices shot higher on Friday, driven by a weakening dollar after U.S. employment data reinforced the view that the Fed is not in a position to increase rates to fend off inflation. Early Friday gains in European equity markets were quickly negated by the employment report. FTSE was up two of five days while the DAX and CAC were down four of five days.

Once again, FTSE losses were smaller than those of the DAX and CAC. The FTSE lost 2.4 percent for the week while the DAX and CAC lost 4.1 percent and 4.4 percent respectively. European investors do not want to hear that there is a possibility of higher interest rates while in the UK, the divide between growth and inflation is more pronounced.

Bank of England and ECB hold rates

As expected, the Bank of England kept its key interest rate at 5 percent for a third month. The Bank’s monetary policy committee last lowered rates by 25 basis points at its April meeting. The MPC is in a bind. Inflation is rising while growth is slowing. In his remarks after the release of the quarterly Inflation Report last month, governor Mervyn King commented that he expected inflation to rise even higher than its current bloated 3 percent level. The Bank has a 2 percent inflation target. Should inflation rise or fall more than 1 percent, the Bank governor is required to write a letter or remit explaining how it planned to bring inflation into line with the target once again.

Recent economic data have been weak including all important house price data which showed prices declining at a more rapid rate. And the services sector PMI released earlier this week showed activity edged below the 50 breakeven reading to 49.8. While new data on industrial and manufacturing output will not be available until this week, both declined more than expected in March. However, it will be extremely difficult for the Bank to think about easing rates until inflation has passed its peak.

The Bank’s 5 percent lending rate is the highest among the Group of Seven nations while Japan's 0.5 percent is the industrialized world's lowest. The Bank issued no statement with the decision. Bank watchers will have to wait two weeks for the minutes of the meeting.

As expected, the European Central Bank kept its policy interest rate at 4 percent. The Bank had been expected to remain in neutral despite its determination above all to keep inflation expectations anchored and not permit second round effects from taking place. However, ECB president Jean Claude Trichet’s post-meeting press conference statement sent shock waves through his listeners. Alarmed by soaring food and fuel prices, he warned unexpectedly that the Bank might raise interest rates next month to counter an inflationary spiral. Declaring the bank to be in a “heightened state of alertness,” Trichet said that risks to price stability had increased and that the governing council had debated whether to lift their key rate at its last meeting before voting to leave it at 4 percent. Safeguarding price stability is the cardinal task of the European Central Bank, which celebrated its 10^th anniversary this week.

The ECB does not hold a formal vote like the Federal Reserve and the Bank of England; rather decisions are made by consensus. Mr. Trichet noted that there were three viewpoints expressed by council members — those who wanted a reduction in interest rates, those who wanted no change and those who wanted an immediate increase. The ECB’s staff once again revised their quarterly inflation projections upward. Inflation as measured by the harmonized index of consumer prices is now expected to average 3.4 percent in 2008 and 2.9 percent in 2009, up sharply from the forecasts made just three months ago.

The HICP remains considerably above the ECB inflation target of 2 percent — in May the index jumped 3.6 percent. And M3 money supply growth, the second of the ECB’s monetary pillars, 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. Economic data for individual EMU states vary. The debate is complicated by a widening divergence in Europe’s economies. For example, countries like Germany are proving resilient, while others — like Ireland and Spain — are suffering from housing market collapses. For them, a rate increase will only add to the pain.

Asia/Pacific

Most Asian/Pacific equity indexes declined last week with the exception of the Nikkei, Topix and Taiex. Japanese indexes were up as the yen declined in value pushing up exporters’ stocks. For the Taiex, this was the first positive week in three. The index was up 1.5 percent on the week and remains the only index in positive territory so far in 2008. Index declines for the week were led by the Sensex (down 5.1 percent) and the Shanghai Composite (down 3 percent). Asia/Pacific markets are closed for the week prior to the U.S. employment report data release.

Earlier in the week, stocks were pressured by Fed chairman Ben Bernanke’s inflation remarks and possible downgrades of mortgage insurers Ambac and MBIA while then declining crude oil prices hurt resource related companies. The All Ordinaries was down three of five days stocks as the steep mid-week fall in crude oil prices pulled energy stocks down. Mining stocks also lost ground on lower commodity prices. During the week, investors shrugged off a better-than-expected merchandise trade deficit and higher-than-expected GDP growth. Kospi was down 1.1 percent on a holiday shortened week trading even though the decline in the won boosted exporters. Investors remained cautious ahead of a three-day weekend. (Financial markets were closed Friday for a public holiday.)

Reserve Bank of Australia

As expected, the Reserve Bank of Australia left its cash rate at a 12 year high of 7.25 percent for the third straight month even though inflation is well above the Bank’s inflation target range of 2 percent to 3 percent. First quarter consumer prices were up 4.2 percent when compared with last year — the fastest pace since 1991. Moderating domestic growth, tighter credit conditions, and difficult conditions contributed to the decision. And recent comments suggest that the Bank may be willing to sacrifice domestic demand in order to get inflation under control. Retail sales were softer while other reports indicated falling consumer and business confidence. In addition, weaker demand for home loans signals that domestic demand has eased recently. However, the RBA believes that a significant slowing in domestic demand is required in order for inflation to return to the target band. In the accompanying statement, the RBA noted that inflation has been high over the past year in an environment of limited spare capacity and earlier strong growth in demand. In these circumstances, the Board has been seeking to restrain demand in order to reduce inflation over time. But rapidly climbing terms of trade and personal income tax cuts which will take effect in July will probably provide second half 2008 stimulus to growth.

Other Asian Banks

Reserve Bank of New Zealand — left its official cash rate (OCR) at a record high of 8.25 percent. In his post-meeting statement, governor Alan Bollard noted the significant increases in oil and food prices in the global economy while growth is slowing. The governor expects CPI inflation to peak at 4.7 percent in the third quarter before returning to its target band of 1 percent to 3 percent.

Bank Indonesia — The Bank increased borrowing costs for the second straight month. It raised the rate used as an indication for bill sales to 8.5 percent from 8.25 percent. Bank Indonesia is trying to keep inflation from exceeding its year-end forecast of 11.5 percent to 12.5 percent as companies pass on higher costs of food and fuel to consumers.

Bangko Sentral ng Pilipinas — The Philippine central bank raised its policy rate by 25 basis points to 5.25 percent, the first increase in more than two years.

Indonesia and the Philippines joined Vietnam and Pakistan who already had increased interest rates last month to combat inflation. Near-record oil prices are combining with surging rice and wheat prices to stoke Asian inflation. India and Malaysia are expected to follow suit after their governments raised gasoline prices to stem crippling subsidy costs. The State Bank of Vietnam raised its policy rate to 12 percent from 8.75 percent on May 19, before a report showed inflation that month surged 25.2 percent. On May 22, Pakistan increased borrowing costs by 1.5 percentage points to 12 percent after the central bank said inflation may average more than 11 percent compared with a prior target of 6.5 percent.

Currencies

After sinking mid-week on Fed chairman Bernanke’s dollar comments, the euro reversed course on Thursday and Friday and soared. The euro rose the most against the dollar since April (and gained versus the yen and the pound as well) after ECB president Trichet said an interest rate increase next month is possible. The euro rally snapped three days of declines against the U.S. dollar. The yen dropped to a three-month low versus the dollar and fell against the euro as an advance in stocks encouraged investors to buy higher-yielding assets funded in low interest rate Japan. And the euro’s climb against the dollar continued Friday after the poor U.S. employment report. The ECB kept its main refinancing rate at a six-year high of 4 percent, where it has been since last June. The Federal Reserve has cut its fed funds target interest rate seven times since September to 2 percent to stave off a recession.

On Tuesday, Ben Bernanke said that the weak dollar had “contributed to the unwelcome rise in import prices and consumer price inflation” and said that the Fed was watching the implications of changes in the dollar’s value for inflation and inflation expectations. The remarks triggered a 2 cent increase in the dollar’s value against the euro in a matter of minutes and dramatic rises against other currencies. It is highly unusual for a Fed official to say anything at all about the dollar. The signal, as far as the currency traders who bought dollars were concerned, was that Mr; Bernanke is the advance guard for a coordinated attempt to bolster the dollar. Treasury bond and Fed Funds futures prices did not react nearly as strongly as the foreign exchange markets. And in the U.S., setting foreign exchange policy is under the purview of the U.S. Treasury, not Mr. Bernanke’s Fed.

Selected currencies — weekly results

Indicator scoreboard

EMU

First quarter growth was revised to 0.8 percent from the flash estimate of 0.7 percent. GDP was up 2.2 percent when compared with the same quarter a year ago. Among expenditure components, fixed capital formation jumped 1.6 percent on top of the 1.0 percent gain already posted in the previous period. Government consumption grew 0.4 percent and inventory accumulation, which subtracted 0.1 percentage points in the fourth quarter, added 0.2 percentage points to the bottom line. Private consumption edged up 0.2 percent after a 0.1 percent decline at the end of 2007.

April producer price index excluding construction jumped by 0.8 percent and was up 6.1 percent when compared with last year and its fastest pace since October 2000. The largest contribution to the latest monthly advance came from the energy sector where prices jumped another 2.0 percent from March to stand some 14.3 percent higher on the year. Excluding energy, the PPI was up 0.4 percent and 3.7 percent on the year. Among the other main categories, intermediates were up a sizeable 0.7 percent on the month, easily outpacing capital goods (0.2 percent), consumer durables (0.1 percent) and consumer nondurables (0.1 percent). Among the larger member states, monthly gains in producer prices were led by Germany (1.1 percent) followed by Spain (0.8 percent), France (0.7 percent) and then Italy (0.4 percent).

April retail sales dropped 0.6 percent after March’s sales were revised downward to a decline of 0.9 percent from a decline of 0.4 percent. Sales are down 3 percent when compared with last year. The monthly drop was led by food, drink & tobacco (down 1.0 percent) but other sectors were still strongly negative (0.5 percent) and in fact have fallen more steeply over the latest three months. Regionally, the April decline was dominated by Germany where purchases collapsed 1.7 percent on top of a 2.2 percent slump in March. Nonetheless, Spain also saw sales down another 0.6 percent and so extended the pattern of monthly falls every month since December. Only Finland (1.1 percent) managed an increase of any real significance.

Germany

April manufacturing orders declined with a surprisingly large 1.8 percent drop — the fifth monthly decline in a row. Orders were up 4.0 percent up when compared with last year. The entire decline was accounted for by overseas purchases which slumped 3.8 percent. Domestic orders edged up 0.3 percent. Within the domestic sector, capital goods (2.6 percent) posted a surprisingly strong monthly gain and were supported by a modest increase in consumer and durable goods (0.4 percent). Even so, much of the aggregate advance here was offset by a hefty decline in basics (2.0 percent). The overseas sector saw large declines in basics (4.9 percent) and capital goods (3.9 percent) that easily eclipsed a solid increase in consumer & durable goods (2.6 percent).

April industrial production dropped 0.8 percent but was up 5.2 percent when compared with last year. The latest decline reflected declines across all of the major sectors bar capital goods which jumped 1.7 percent from March. Intermediate goods were down 2.2 percent while consumer goods slumped an even more marked 2.5 percent, largely on the back of a 2.9 percent nosedive in nondurables. Overall manufacturing was off 0.7 percent while construction dropped another 2.9 percent on top of its 13.9 percent collapse in March. Energy output was off 1.7 percent.

France

First quarter overall unemployment rate as measured by the International Labour Organisation definition declined to 7.5 percent from 7.8 percent in the fourth quarter of 2007. For mainland France only, the comparable figure was 7.2 percent, down from a lower revised 7.4 percent rate at the end of last year, and its lowest level since the first quarter of 1983. In metropolitan France, the drop in unemployment was prompted by a surprisingly large 0.4 percentage point jump in the employment rate to 65.1 percent. The activity rate meantime, edged up another 0.1 percent to 70.1 percent.

April merchandise trade deficit narrowed to €3.7 billion from a smaller revised €4.3 billion shortfall in March. However, over the first four months of the year, the red ink still expanded to €13.4 billion, almost 40 percent larger than the same period of 2007. The contraction in the deficit reflected a 1.4 percent monthly gain in exports combined with a 0.2 percent dip in imports. Over the January-April period, imports still lead the way with annual growth of 10.0 percent versus a rise in exports of 8.0 percent.

Asia/Pacific

Australia

April retail sales edged down 0.2 percent after increasing 0.2 percent in March. Sales were up 4.7 percent when compared with the same month a year ago. Food sales dropped 1.1 percent while recreational goods retailing was down 1.2 percent and other retailing drifted down 0.7 percent. On the positive side were department store sales which were up 1.9 percent, clothing and soft goods which were up 2.9 percent and household goods which increased by 0.4 percent.

First quarter GDP was up 0.6 percent and 3.6 percent when compared with the same quarter a year ago. Non-farm GDP increased by 0.7 percent while the terms of trade rose 1.1 percent. Real gross domestic income was up 0.8 percent. Growth was driven by gross fixed capital formation which jumped 1.6 percent and 6.6 percent on the year. Final consumption expenditures were up a healthy 0.6 percent and 4.1 percent on the year. The main contributors to higher expenditures were household final consumption expenditure, new engineering construction and national defense capital expenditure. The largest negative contribution came from imports. The GDP chain price index was up 1.3 percent on the quarter and 3.1 percent on the year showing that inflation remains a worry regardless of the price measure.

April unadjusted merchandise trade deficit narrowed to A$2,034 million. On a seasonally adjusted basis, the goods and services deficit was A$957 million, down from A$ 2.547 million in March. The decrease was due to the increase in goods and services exports, mainly non-rural and other goods, and the decline in goods and services imports, mainly capital goods and consumption goods. Imports were down 2.2 percent. Among the components that accounted the most for the decline were capital goods which were down 10 percent and consumption goods which were down 6 percent. Intermediate and other goods were up 3 percent while services were up 1 percent. Exports were up 5.8 percent to A$20,446 million. Non-rural and other goods were up a healthy 7 percent while rural goods were up 6 percent. The increase in exports was driven by coal, coke and briquettes and non-monetary gold.

Americas

Canada

May employment was up by 8,400 jobs. Full time jobs were down 32,200 while part time employment increased by 40,600. The unemployment rate held steady at 6.1 percent. All of the employment growth last month was accounted for by the goods producing sector where overall payrolls climbed 28,600. The gain here was essentially attributable to manufacturing where jobs spurted 34,200 courtesy of hefty gains in Ontario and Quebec. There were also much smaller increases in construction (7,400) and utilities (1,700) but these were more than offset by declines in agriculture (10,100) and natural resources (4,400). By contrast, the services sector saw employment drop 20,200 with declines particularly marked in trade (13,900), educational services (13,400), professional, scientific & technical services (16,100) and transport & warehousing (7,800). The only gain of note in this area was in health care & social assistance (21,700) although other services (14,100) also held up quite well. The public sector contracted by 6,900 leaving a 32,000 increase in private jobs to ensure a positive handle. Unemployment rose 13,400 over April as the labor force expanded by 21,800 but employment was up by just 8,400. The jobless total now stands 39,200 higher than in the same month a year ago.

Bottom line

Inflation and stagflation were the worries of the week, as central bankers in succession fretted over climbing prices, especially those for food and fuel. Although the Reserve Bank of Australia, Bank of England and European Central Bank kept their policy rates unchanged at 7.25 percent, 5 percent and 4 percent respectively, statements from the RBA and ECB were blunt in their concerns about inflation. The Bank of England does not issue a post-meeting statement except in rare circumstances and when there is a policy change. All financial markets were volatile on the week.

The Banks of Canada and Japan meet this week while the Federal Reserve publishes its Beige Book of anecdotal economic information. While the Bank of Canada is expected to nudge rates down another 25 basis points to 2.75 percent, the Bank of Japan is expected maintain its neutral position and keep its key interest rate at 0.5 percent.

Looking Ahead: June 9 through June 13, 2008

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