Global Markets

Inflation fears and interest rate concerns continued to dog investors last week. Central banker rhetoric — and in some cases action — ratcheted up inflation concerns in the monetary policy debate. Many of the emerging market countries including Vietnam, Indonesia and the Philippines have already increased rates to fight inflation. And last week they were joined by the Reserve Bank of India. While the People’s Bank of China did not increase its policy interest rate, it did increase bank reserve requirements. The tough stance among central bankers was reinforced on Tuesday when the Bank of Canada shocked markets and kept its key interest rate unchanged at 3 percent instead of reducing it as almost universally expected.

Rhetoric intensified between central banks as several Federal Reserve and European Central Bank leaders tried to press their inflation fighting credentials upon the listening public. Jürgen Stark, an ECB executive board member, tempered earlier comments by ECB president Jean Claude Trichet and signaled that eurozone interest rates were unlikely to be raised more than once. His comments came after ECB president Jean Claude Trichet stunned the markets at his post ECB meeting press conference by warning that a rate increase was possible as soon as the July meeting. He roiled the financial markets and had been somewhat ambiguous however about the number of possible increases.

Only the Dow managed to gain on the week. Losses ranged from 0.1 percent (S&P 500) to 13.8 percent (Shanghai Composite). Thanks to the Fed’s inflation-fighting rhetoric, the dollar was up against most currencies last week.

Global Stock Market Recap

Europe and the UK

Gains on Thursday and Friday did not prevent the FTSE, CAC and DAX from declining last week. This was the fourth consecutive down week for the FTSE and the second for the CAC and DAX. Investors appear to be convinced that they are heading for an environment of sub-trend growth and higher inflation or a form of stagflation. Investor performance continues to be led by changes in oil prices and the day-to-day changes in the U.S. outlook. For example, stocks were up on Friday after oil prices fell and reports on inflation and consumer confidence in the U.S. eased concern that the Federal Reserve will be quick to raise interest rates. On Thursday, stocks were aided by a merger bid by InBev NV for Anheuser-Busch and banks rebounded. A big negative for the FTSE has been sinking consumer confidence amid falling house prices and soaring inflation. Banks fell in the UK as investors worried that the outlook for inflation would hamper the Bank of England’s efforts to boost flagging growth and help restore liquidity to parched money markets. On the week, the FTSE was down 1.8 percent, the DAX was down 0.6 percent while the CAC dropped 2.4 percent.

Asia/Pacific

Asian/Pacific equity markets sank last week burdened by heightened inflation fears thanks to ever climbing oil prices and central bank rhetoric. All indexes followed here lost anywhere from 13.8 percent (Shanghai Composite) to the Malaysian KLSE Composite which was down 1.5 percent and the Jakarta Composite which was down 0.2 percent. All other indexes were down between 2.4 percent (Sensex) and 7.4 percent (Hang Seng). The Japanese indexes were helped Friday by the declining value of the yen ahead of the Group of Eight meeting. A weaker yen supports exporters such as automakers and electronics firms while oil prices support resource-related stocks. During the week, several indexes dropped below psychologically significant numbers. The Nikkei dropped below 14,000, the Shanghai Composite below 3,000 and the Hang Seng dipped below 23,000. On Friday, Asian stocks were up led by auto and electronics makers after U.S. retail sales advanced at twice the forecast pace and boosting speculation that consumer spending will hold up.

Shares on the mainland of China sank to their lowest levels in 15 months. The Shanghai Composite tumbled for the eight trading day after the People’s Bank of China increased bank reserve requirements over the weekend. And despite a better than expected May consumer inflation report, the good news failed to stop the market’s slide The index closed below the 3,000 mark for the first time since February 2007. The index lost 13.8 percent last week and is now down 45.5 percent in 2008.

The Sensex, already down on concerns that record oil prices will fuel inflation and hurt economic growth, stumbled further as the Reserve Bank of India increased interest rates by 25 basis points to 8 percent. Rising fuel and food costs have caused India's inflation rate to accelerate to the fastest since August 2004, adding pressure on the central bank to raise interest rates. Wholesale price increases accelerated for the seventh week. The Sensex is Asia's third worst performer this year. India imports about 70 percent of its oil. The Sensex was down 2.5 percent on the week and is down 25.1 percent so far in 2008.

The South Korean Kospi was down 4.6 percent last week thanks in part to political uncertainty and inflation woes. Seoul stocks were sharply lower amid growing political instability and fears of global monetary tightening to fight rising inflation. The South Korean prime minister and the entire cabinet offered to quit as protesters threatened to stage their biggest-ever rally over the government's plan to resume U.S. beef imports. Earlier in the week, investors were also cautious ahead of the Bank of Korea's rate decision meeting and the expiry of options and futures contracts scheduled for Thursday. Stocks declined after the Bank left interest rates unchanged at a seven-year high of 5.0 percent for the 10th straight month.

People’s Bank of China lifts reserve requirements

Over last weekend, the People's Bank of China announced that the reserve requirement ratio (RRR) for financial institutions' yuan deposits will be raised again by 100 basis points in two steps — to 17 percent effective from June 15 and to 17.5 percent effective from June 25. As in past RRR moves, the PBoC emphasized that the purpose of the increase is to manage banking sector liquidity conditions. Meanwhile, to ensure funding supply for disaster relief and reconstruction, the Bank again deferred the RRR hike temporarily for quake-affected areas. The latest RRR increase will freeze about 420 billion yuan (equivalent of US$60.7 billion) in the banking system, reflecting the Bank’s intention to absorb excess domestic liquidity from rapidly increasing foreign exchange reserves. In recent years, the central bank has been using a combination of policy tools to withdraw excess liquidity from the domestic financial system, including normal issuance of PBoC sterilization bills as well as frequent increases in the RRR.

Reserve Bank of India ups rates

The Reserve Bank of India unexpectedly raised interest rates for the first time in 15 months to combat an inflation surge sparked by food and energy costs. The RBI increased the repurchase rate by 25 basis points to 8 percent. The move came seven weeks before the Bank's scheduled July 29 monetary policy meeting. The urgency signals governor Yaga Venugopal Reddy’s concerns after India raised fuel prices at the sharpest pace in at least six years. Higher rates have already hurt consumer demand and slowed India's economic growth rate to 9 percent in the year ended March 31, the slowest in three years. Later in the week, evidence of soaring inflationary pressures was apparent — wholesale prices jumped 8.75 percent in the week to May 31, after gaining 8.24 percent in the previous week. The Reserve Bank of India joined a growing list of Asian central banks that are opting to tackle inflation at the expense of economic growth by raising its key "repo" lending rate with a view to containing inflation expectations. The RBI's move reflects rising concern about inflation across Asia, with central banks in Vietnam, Indonesia and the Philippines also increasing rates recently.

Bank of Japan on hold

As expected, the Bank of Japan’s monetary policy board left its policy interest rate unchanged at 0.5 percent amid an uncertain economic outlook. High on the agenda was the impact of rising prices on the real economy as rising energy and commodity prices erode profits and discourage spending. Some analysts suspect the core consumer price index for May excluding only fresh foods will rise around 1.5 percent on the year, up from a 0.9 percent increase in April. Another area of concern for the board is the flagging pace of export growth. The bank attributes the decline to production factors, but some see exports as unable to maintain previous sharp gains amid a global economic slowdown. Signs that higher prices are squeezing companies prompted the government to say that the nation's longest postwar expansion may be over. Policy is being complicated by the fact that record oil costs are spurring inflation while also crimping demand. Companies are being forced to pass on higher costs as margins are already suffering from elevated prices and slowing growth. Profits declined by almost a fifth in the first quarter.

At his post-meeting press conference, governor Masaaki Shirakawa noted increasing global inflation risks that prompted investors to expect a U.S. interest rate increase. Shirakawa said that global inflation risk is rising. He also added that since the economic situation varies by country, each central bank would set monetary policy based on the situation in the respective countries. His comments prompted some yen selling as it was not as hawkish as some investors had anticipated and increased their expectations that Japan will not raise its rates anytime soon.

Canada

On Tuesday, the Bank of Canada surprised and kept its key interest rate at 3 percent. Analysts had expected the Bank to lower rates by 25 basis points to 2.75 percent and then pause. The Canadian rate is 1 percentage point above the fed funds target rate of 2.0 percent. The key rate had been increased to 4.5 percent at the July 2007 meeting. But since then, the Bank lowered its key rate at the December 2007, January, March and April 2008 meetings.

The Bank had been lowering rates amid signs that the U.S., the destination for about 80 percent of Canada’s exports, could slide into recession. First quarter GDP declined 0.1 percent on the quarter for the first decline since the second quarter of 2003. Retail sales have been holding up after a dreadful December and manufacturing shipments, after surprising pleasantly in both January and February, took a nasty tumble in March. In data released on Friday, shipments did rebound once again in April.

The Bank of Canada has an inflation target range of 1 percent to 3 percent but focuses on the 2 percent midpoint. Inflation as measured by the CPI has remained contained, giving the Bank the latitude to adjust interest rates in response to changes in growth. Record crude oil prices have been boosting the economy and the Canadian dollar which has remained at plus or minus parity with the U.S. dollar since the fall. In keeping its rate at 3 percent, the Bank said that energy costs threaten to push inflation above 3 percent, the upper limit of the bank's target range, policy makers said. The decision to pause to contain inflation as global food and energy prices surge brings Canadian policy into line with counterparts in the UK, U.S., EMU and elsewhere.

Currencies

The U.S. dollar rose against most currencies last week prior to the Group of Eight finance ministers meeting in Osaka, Japan on June 13 and 14. There were several reasons for the increase. The currency climbed to a one-month high against the euro on bets that G8 will signal they favor a stronger dollar. (Foreign exchange is not on the official agenda however.) Traders also think the Federal Reserve will increase borrowing costs this year. And on Friday the euro weakened as Irish voters turned down the European Union's Lisbon treaty — certainly a setback for the bloc's plans to strengthen its global voice. While most of the focus remained on the euro, the yen sank against the dollar on persistent expectations of an interest rate increase later this year by the Fed to combat inflation.

The rhetoric in defense of the dollar intensified in the last two weeks. Fed Chairman Ben S. Bernanke said on June 3 that he's aware of the impact a falling currency can have on price expectations. The dollar advanced on Tuesday after several senior administration officials made it clear they wanted the currency to become stronger. Top officials at the Federal Reserve and the Treasury — and even president George W. Bush — threw their weight behind the currency, prompting a wave of dollar buying that swept on through on Tuesday. Their comments were taken by the currency market as a sign that America’s political and economic leaders were working together to halt the currency’s decline. But markets paid closest attention to Bernanke who warned that inflation risks were rising because of soaring energy prices. He said the Fed would “strongly resist” rising inflation expectations — his clearest remark yet that the central bank had finished cutting interest rates.

Selected currencies — weekly results

Indicator scoreboard

EMU

April industrial production jumped 0.9 percent and was up 3.9 percent when compared with last year. The monthly rebound in April was driven by capital goods (2.0 percent), which more than unwound their March slump, and durable consumer goods (1.7 percent) which similarly erased a hefty a decline posted in the previous period. Capital goods production now shows annual growth of 7.5 percent, its fastest pace in 2008. There were smaller increases in output in both intermediates (0.3 percent) and nondurable consumer goods (0.2 percent) leaving the only contraction to the energy sector (1.4 percent). Amongst larger states, there were sizeable monthly gains in output in France (1.4 percent), Spain (1.2 percent) and Italy (0.7 percent) which contrasted with a marked fall in Germany (0.7 percent).

Germany

April merchandise trade surplus jumped to €17.7 billion from €15.3 billion in March. Exports were up 1.2 percent while imports dropped 2.1 percent. Exports were 13.9 percent higher on the year. Purchases by non-EU countries were up a particularly impressive 18.4 percent and by EU states a more subdued but still solid 11.6 percent. The monthly decline in imports meantime was the steepest since last November (3.0 percent) and reduced annual growth to 11.7 percent. Imports from non-EU countries were 12.1 percent higher on the year while purchases from the EU bloc rose 11.4 percent.

France

April industrial production excluding construction was up 1.4 percent after sinking 1.0 percent in the previous month. Output was up 3.2 percent when compared with last year. The monthly gain reflected a solid pick-up in manufacturing where output rose 1.7 percent following a 1.6 percent slump in March. Within this sector, the most notable advance was achieved by the auto industry (3.8 percent) where output increased for the first time in three months. Other major gains were seen in clothing & leather (2.4 percent), capital goods (2.0 percent) and semi-finished goods (1.6 percent) for which chemicals, plastics & rubber (3.1 percent) made an impressive contribution. Energy production climbed 2.0 percent and stands 9.0 percent higher on the year while activity in the construction industry showed a more modest 0.5 percent monthly gain for annual growth of 3.3 percent. The only decline of substance occurred in the wood & paper products area where output dropped 1.6 percent from March putting the annual rise at just 0.4 percent.

Italy

April industrial output was up 0.7 percent and 2.0 percent when compared with last year. The April bounce was relatively broad-based and led by markedly higher output in the capital goods sector (1.5 percent). Other gains were posted by intermediates (0.7 percent) and, to a lesser extent, consumer goods (0.3 percent). The only decline was registered by energy (1.2 percent).

First quarter gross domestic product was unexpectedly revised up a notch to 0.5 percent and by the same degree to 0.3 percent on the year. The details confirm the weakness of domestic demand which contributed just 0.1 percentage point to the headline quarterly rate. Household consumption was up 0.1 percent following a 0.4 percent drop in the pervious quarter. Fixed investment dipped 0.2 percent thanks to a 3.4 percent slump in transportation. With government consumption restrained at 0.2 percent on the quarter, and inventories subtracting 0.2 percentage points, the biggest impetus to growth came from exports which jumped 1.4 percent. By contrast, the sluggishness of domestic demand was highlighted in imports which dropped 0.5 percent. Annual growth was similarly driven by net trade with exports up 0.7 percent and imports down 1.0 percent. Annual growth in private consumption was a meager 0.1 percent leaving a 0.8 percent gain in government spending to boost total consumption growth to a still very sluggish 0.3 percent. Over the year, investment contracted 0.3 percent with declines in both machinery (0.9 percent) and transportation (0.6 percent).

United Kingdom

May producer output prices were up 1.6 percent and 8.9 percent when compared with last year — a new record. As usual, the main pressure came from food and, in particular, petroleum products. Food costs were up 2.0 percent on the month and now stand 11.0 percent higher than a year ago. Petrol prices rose a still larger 3.9 percent from April and have now risen 28.5 percent from May 2007. Food and petrol combined account for nearly half of the annual increase in the overall PPI. However, even excluding food, drink, tobacco & petroleum, the core index was up a still hefty 1.2 percent, matching its April advance and raising annual growth from 4.6 percent to 5.9 percent. All categories registered monthly gains including significant increases in chemicals (0.7 percent), metal products (0.6 percent), paper (0.5 percent) and other products (3.7 percent). May producer input price index soared 3.8 percent on the month and 27.9 percent on the year. Dominating the monthly rise was crude oil which surged 11.0 percent and now stands a full 83.8 percent higher than in May 2007. Other monthly increases were much more subdued although there were still sizeable advances posted by imported food materials (2.7 percent), imported chemicals (1.5 percent) and other imported materials (1.7 percent).

April industrial production edged up 0.2 percent and was also up 0.2 percent when compared with last year. Components were mixed. While there was a hefty monthly increase in output of electricity, gas & water (1.6 percent) and just a minimal gain in manufacturing (0.1 percent), mining & quarrying saw a decline (0.3 percent) while oil & gas extraction sank (1.1 percent). Manufacturing output edged up 0.1 percent and also was up 0.1 percent on the year. Production over the latest three months stood 0.3 percent higher than in the pervious period. Overall output growth was aided by a 2.8 percent increase in transport equipment. This was chiefly thanks to a 4.1 percent rise in aircraft and a 2.6 percent advance in car output.

April merchandise trade gap widened to Stg7.6 billion. Exports posted a solid gain of 3.7 percent but were outpaced by a surprisingly sharp 4.4 percent advance in imports. The underlying shortfall, excluding oil and erratics, rose from Stg6.8 billion to Stg7.0 billion. The deterioration in the headline from a smaller revised Stg7.1 billion in March was mainly due to a larger bilateral shortfall with non-EU countries where the deficit grew to Stg4.2 billion from Stg3.8 billion, largely as a result of higher aircraft imports. The deficit with the EU bloc was essentially unchanged at Stg3.4 billion.

Average annual earnings growth for the three months to April decelerated from 4.0 percent to 3.8 percent. The equivalent ex-bonus rate edged up a notch to 3.9 percent. The surprisingly soft headline rate was due to a sharp slowdown in annual growth in April alone which fell from 4.7 percent to just 3.2 percent, its weakest reading since June 2007. Amongst the sectors, headline average earnings slipped to 3.8 percent in the private sector while holding steady at 4.0 percent in the public sector. In manufacturing, the headline rate dropped from 3.8 percent to 3.5 percent, its slowest pace so far in 2008 and in services it eased from 4.4 percent to 4.2 percent, its lowest level in three months.

May claimant count unemployment was up 9,000 but the unemployment rate remained unchanged at the 2.5 percent level first reached in November. It was the fourth monthly increase in a row. The May advance implies that unemployment has risen by 24,400 since its cyclical trough in January (794,900). The ILO unemployment rate edged a notch higher to 5.3 percent in the three months to April. The higher rate was driven by a 38,000 increase in the number of jobless, the largest rise since April through July 2006.

Asia/Pacific

Japan

May corporate goods price index soared by a greater than expected 1.1 percent and was up 4.7 percent when compared with May of last year. It marked the 8th straight month of increases under the recently revised formula thanks to strong international commodity prices. The reason for higher prices is evident in the import price index which is released at the same time. Import prices on a yen basis jumped 4.3 percent on the month and 10.8 percent on the year. Domestic prices were up thanks to higher prices for petroleum & coal products, iron & steel, processed foodstuffs, chemicals & related products and metal products. The CGPI is likely to maintain its upward trend, depending on future developments in the prices of crude oil and other commodities as well as foreign exchange rates.

First quarter gross domestic product was revised upward to an increase of 1.0 percent on the quarter from the original estimate of 0.8 percent. GDP was up 1.3 percent when compared with the same quarter a year ago. GDP was up at an annualized rate of 4.0 percent. The original estimate had been 1.0 percent. Several components were upwardly revised, including domestic demand, which was revised upward from 0.3 percent to 0.5 percent. Within domestic demand, private demand was up 0.7 percent and 2.7 percent on the year. Private nonresidential investment was revised from a decline of 0.9 percent to an increase of 0.2 percent. Government consumption was also revised upward, from minus 0.8 percent to minus 0.4 percent on the quarter.

Australia

May employment surprised analysts and declined for the first time since October 2006. Employment declined 19,700 to 10,691,200. Full time employment dropped by 10,400 while part time employment declined by 9,300 jobs. While the labor force remains tight thanks to labor demand in the resource producing industries, analysts were anticipating that there would be a moderation in labor force growth in the second half given the easing of demand and sinking consumer confidence. Unemployment remained steady at 476,700 and the unemployment rate was unchanged at 4.3 percent. The number of persons looking for full-time work decreased by 17,900 to 317,700 and the number of persons looking for part-time work increased by 18,000 to 159,000. The participation rate declined to 65.2 percent from 65.5 percent.

China

May merchandise trade surplus continued to recover after hitting an 11-month low in February, widening to US$20.2 billion. For the first five months of this year, the surplus totaled $78.5 billion, 8.5 percent below the same period last year. Merchandise exports soared 28.1 percent when compared with the same month a year ago. In April, exports jumped by 21.8 percent. On the month, seasonally adjusted exports were up 8.8 percent after rising by 4.8 percent in the previous month. May imports soared by 40.0 percent on the year and the strongest pace since June 2004. Imports were up 13.7 percent on the month.

May consumer price index was up 7.7 percent from a year earlier and down from April’s reading of 8.5 percent. The lower inflation reading reflected easing prices in food, which had driven most of the recent run-up in the CPI as well as other goods and services. Nonfood prices eased to a 1.7 percent increase from 1.8 percent in April and the first decline since last July.

Americas

Canada

April merchandise trade surplus narrowed to C$5.1 billion from C$5.7 billion as a 0.8 percent monthly increase in exports was easily outpaced by a 2.6 percent advance by imports. The surplus with the U.S. narrowed to C$8.2 billion despite the fourth consecutive increase in exports to C$30.6 billion, their highest level since April last year. Within total exports, the most pronounced gains were registered by energy products (2.5 percent) and forestry products. Growth here was partially offset by declines in agriculture and fishing (1.3 percent), automotive products (0.6 percent) and other consumer goods (5.6 percent). Making the biggest impact on the other side of the balance sheet were energy imports (19.0 percent) where volumes surged three times more quickly than prices. There was also a sizeable gain in automotive products (4.7 percent) despite the ongoing effects of the labor dispute across the border. Other sectors posted small increases and there were drops in imports of forestry products (1.7 percent), industrial goods & materials (1.4 percent) and machinery & equipment (0.6 percent).

April manufacturers’ shipments soared 2.0 percent on the month but were still down 5.5 percent when compared with last year. Seventeen of the twenty-one reporting industries representing 80 percent of sales registered gains. The latest increase in was led by petroleum and coal products (9.0 percent) with shipments exceeding C$7.0 billion for the first time. Even so, excluding petroleum sales still rose a very respectable 1.0 percent. The other main contributor was the auto industry (1.8 percent), although the jump in shipments here followed a 5.9 percent slump in the pervious period. Partially offsetting these advances was a hefty drop in sales in the aerospace products (25.2 percent) but this still failed to offset sizeable increases in both February (13.4 percent) and March 16.6 percent). There was also good news on backlogs which rose a further 0.4 percent after the aerospace-led 3.9 percent surge in March but new orders fell a disappointing large 2.0 percent.

Bottom line

The focus last week was on inflation and the heightened rhetoric on the subject by central bankers. With the Group of Eight Finance Ministers meeting in Osaka this weekend, due diligence was paid to its value by ranking administration officials who appear to have discarded their benign neglect approach to the dollar. Global bond markets were battered but the dollar found solid support as central bankers continued to focus on the threat posed by inflation. Most inflation readings last week were troublesome including those in France, Japan and India. While the core CPI data from the U.S. prompted a relief rally, the overall number gave pause for concern. In the bond market, longer term yields were up even though the focus was on 2-year maturity bonds given their sensitivity to central bank policy changes. The Bank of Canada kept its policy rate steady, surprising investors who had expected a cut.

Inflation will be the focus this week as well. On Tuesday, the UK will release its consumer price index for May. Should inflation soar above the threshold 3 percent level, the Bank of England will have to send a public letter to the Treasury explaining the jump in prices. Bank governor Mervyn King is required to write to the Chancellor if consumer price inflation moves more than a percentage point from its target rate of 2 percent explaining why it has shifted so far and what the Bank is doing to address it. In its 10 years of independence, the Bank has only had to write one letter, last April.

Looking Ahead: June 16 through June 20, 2008

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