Global Markets

Equities were downbeat as the second half of 2008 began, continuing the latest downtrend that began in mid-May. Most indexes gave back all — or most — of their hard earned gains from their March lows. All indexes followed here suffered major losses on the week through Thursday. Oil prices continued to surge as the third quarter began and continued to put intense pressure on global equities. Inflationary worries were not eased after the latest outlook from the International Energy Agency warned of slowing supply and minimal spare capacity. Evidence of inflationary pressures has been rising as input prices have skyrocketed forcing companies to raise prices to consumers. And economic data in Europe and the U.S. indicated weakening output (virtually all purchasing managers’ indexes are under the 50 breakeven point) and soaring producer and consumer prices. And although employment declined for the sixth consecutive month in the U.S., the decline was anticipated by analysts and the markets. Reaction to the report was diluted by comments from ECB president Jean Claude Trichet at his monthly post meeting press conference.

For the record — the second quarter

Most indexes followed here peaked mid-quarter and then began to decline. Canada’s S&P/TSX Composite actually closed at an all time high on June 18 — but managed to lose ground that week anyhow. However, the index gained a healthy 8.4 percent in the second quarter and was the only index above its 2007 close. Other indexes that were up in the second quarter included the Nikkei (up 7.6 percent), the Topix (up 8.8 percent) and the Nasdaq (up 0.6 percent). Quarterly losses ranged from 1.3 percent (FTSE) to 21.2 percent (Shanghai Composite).

Selected Global Stock Market Indexes — 2008 Quarterly Results

Global Stock Market Recap

Europe and the UK

Stocks were positive on Thursday and helped cut losses sustained earlier in the week. Through Thursday, the FTSE, DAX and CAC were down 1.0 percent, 1.1 percent and 1.2 percent respectively. Thursday’s gains were led by financial stocks after European Central Bank president Jean Claude Trichet eased concerns that the Bank would keep raising interest rates to contain inflation. Stocks were also boosted by dollar-positive news that helped ease pressures on oil prices. Worries that the U.S. employment report would be weaker than anticipated combined with the fear of more hawkish statements from Mr .Trichet sent equities into a tail spin to three-year lows during morning trading while at the same time oil rose to a record above $146 a barrel and the dollar came close to its record low against the euro. However, U.S. job losses were exactly in line with expectations and Mr. Trichet suggested that today’s 25 basis point increase may have been a one-time event. Stocks rallied in afternoon trading.

The three indexes were down every week during the month of June. The FTSE has been negative for every week since May 16 while the CAC and DAX have been down each week since the week ending May 30. The FTSE, DAX and CAC were down 1.3 percent, 1.8 percent and 5.8 percent respectively in the second quarter. 

European Central Bank increases rates as expected

As expected by virtually all analysts, the European Central Bank increased its key policy interest rate by 25 basis points to 4.25 percent. The spread between U.S. and EMU interest rates is now 2.25 percent. The latest flash reading for the harmonized index of consumer prices showed that inflation soared by 4 percent in June, the highest rate since statistics began in 1997. That means that inflation is double the ECB’s inflation target of below but close to 2 percent. And producer prices soared by 7.1 percent on the year in May. In a recent interview, ECB president Jean Claude Trichet warned that there is a risk of inflation exploding if central banks do not act decisively.

In the press conference after the ECB’s June meeting, Trichet shocked analysts with his hawkish language. He said the bank may raise its key rate by a quarter-point to 4.25 percent at its July 3 meeting to contain inflation even as economic growth slows. This was immediately interpreted by the financial markets that there was a series of rate increases on the near horizon. Subsequently, members of the governing council have attempted to smooth the remarks to mean that there would be only one rate increase. Since then, soaring food and energy prices pushed eurozone inflation to 4 percent. Policy makers are concerned that workers will demand wage increases to compensate for the higher cost of living, which would entrench inflation. The ECB's thinking is that even though higher rates may hurt growth in the short term, the longer-term economic fallout would be much worse if it doesn't act now.

Still, for some eurozone economies, a rate increase is unwelcome. That is the downside of a currency union, but the ECB sets interest rates for the eurozone as a whole. The right monetary policy stance is not always the stance that makes life easy in the short term.

During his press conference Mr. Trichet stressed that the decision to raise rates was unanimous and that the ECB would do whatever was necessary to deliver on its mandate of price stability. He stated that the primary concern of the eurozone citizens is inflation and said that there was “absolutely no contradiction” between the ECB's mandate and what the people want. Trichet pointed to increasing price stability risks but at the same time emphasized that the Bank's mandate was to deliver on price stability and anchor inflation expectations. He also emphasized that the central bank needed to be credible in the delivery of its monetary policy and that confidence in the ECB was essential. Analysts opined that the comments were less hawkish than expected, and implied the rate rise was a one-off, in contrast to the series of rate rises that were priced into the markets. Trichet dismissed the interpretation of “strong vigilance” and “heightened alertness” as code words and emphasized that the ECB would communicate its decisions clearly.

Asia/Pacific

All stocks in this region were down on the week through Thursday as equities continued to get hammered by skyrocketing resource prices, renewed jitters surrounding the U.S. financial system and weak U.S. and European economic data. Losses for the week ranged from 1.6 percent for the Shanghai Composite to 4.6 percent for the Kospi and 4.8 percent for the All Ordinaries.

The Nikkei was down for the 11^th straight day, marking the longest string of declines in 55 years and reflecting investor worries about the global economic slowdown. The Nikkei's longest losing streak was a 15-day stretch in 1954. Overseas growth is a major concern for an economy that is dependent upon exports for growth. For example, steel company stocks were hit especially hard on concern that a slump in U.S. auto sales would cut demand for steel. Japanese carmaker stocks dropped thanks to disappointing U.S. car sales. The Nikkei and Topix were both up in the second quarter after a disastrous first quarter. The Nikkei was up 7.6 percent in the second quarter after sinking 18.2 percent in the first. The Topix gained 8.8 percent in the second quarter after sinking 17.8 percent in the first. This is in stark contrast to the Shanghai Composite — it plummeted 34 percent in the first quarter and 21.2 percent in the second.

While the first quarter equity slide was led by global financial turmoil and risk aversion, the recent rout has been attributed to the growing risk of stagflation in Asia. Both domestic and foreign investors remain wary about the impact of food and fuel prices on the wage-price spiral and the cost of energy subsidies in many Asian countries despite reductions of late.

South Korea said it may limit bank lending and “stabilize” a slide in the won in an attempt to cool the fastest inflation in a decade. Stocks dropped and the won rose. The Kospi index dropped on concern less credit will restrain investment. South Korean authorities actively intervened in the currency markets once again Wednesday. It is estimated that South Korea has bought about $7 billion worth of won since the end of May to help stem its decline. Consumer prices in Korea surged 5.5 percent in June from a year earlier, led by rising fuel and import costs. The Bank of Korea raised interest rates seven times since October 2005.

Reserve Bank of Australia

As expected, the Reserve Bank of Australia left its benchmark interest rate at a 12-year high of 7.25 percent where it has been since March. Current policy settings appear to be delivering the desired significant moderation in domestic demand that the RBA believes is required to help curb inflation. Of late, the economy has been hit with higher borrowing costs, a sinking stock market and record gasoline prices which have in turn crushed consumer and business confidence. Businesses have been trimming expenses in order to combat rising costs. Surging fuel, food and housing costs pushed first quarter annual core inflation to 4.4 percent, the highest rate in almost 17 years. The RBA has an inflation target range of 2 percent to 3 percent. Since its last meeting, economic news indicates that growth is slowing. For example, employment declined in May for the first time since October 2006, ending the longest run of monthly job gains since 1978. Since May 2002, the RBA has increased interest rates 12 times and has continued to increase rates despite cuts by the Federal Reserve and the Banks of Canada and England.

In its post meeting statement the RBA noted that as a result of earlier decisions additional increases in interest rates and tougher credit standards for some borrowers, there has been a substantial tightening in financial conditions since the middle of last year. The statement said that conditions in international financial markets remained difficult, with credit concerns resurfacing in the past month. The evidence is that the tightening in financial conditions, in conjunction with other factors including rising fuel costs, is working to restrain demand. Indicators of household spending have recorded subdued outcomes over recent months, and credit expansion to both households and businesses has weakened significantly. There have also been some tentative signs of an easing in labor market conditions.

Currencies

The euro dropped against the U.S. dollar and the pound sterling after ECB President Trichet indicated that he might not increase interest rates soon again after today’s 25 basis point increase to 4.25 percent. After edging up to near the record high prior to today’s announcement, the euro steadily sank the most against the dollar in more than two months after the ECB indicated that it might have reached the end of its monetary tightening cycle and has reverted to a neutral stance. The dollar has traded in the $1.53 to $1.59 range over the past two months. The dollar has continued to lose ground against the euro since the Federal Reserve began reducing its fed funds target rate in September 2007. The yen also declined Thursday, reversing gains recorded earlier in the week.

Selected currencies — weekly results

Indicator scoreboard

EMU

June flash harmonized index of consumer prices soared to a record 4.0 percent on the year, twice that of the inflation ceiling established by the ECB. The increase was attributed to high energy prices as well as rising services prices. As with all flash estimates, no detail was available. However, it is expected that energy prices will be reflected in certain core service components such as transport.

May unemployment rate was 7.2 percent. The number of unemployed increased by 42,000, less than the hefty 60,000 increase in April. Across the larger member states, there was another sizeable monthly increase in the jobless rate in Spain (9.9 percent from 9.6 percent) while in Germany the rate was unchanged (7.4 percent) and in France there was a small decline (7.4 percent from 7.5 percent).

May retail sales jumped 1.2 percent after three consecutive monthly declines. However, volumes were still only 0.2 percent up on the year and, more worryingly, April/May sales were 0.8 percent below their first quarter average. The rebound was led by non-food stores which saw purchases surge 1.7 percent on the month. Food sales were up a more restrained 0.5 percent. Regionally the recovery was propelled by Germany (1.3 percent) although the upturn here still failed to offset an especially steep decline in March/April. Other gains among those countries providing data were restricted to Belgium (0.7 percent), Luxembourg (4.6 percent), Austria (1.6 percent) and Portugal (1.1 percent). Against this there was yet another drop in Spain (1.0 percent) where sales have weakened every month so far this year. Finland (1.3 percent) also saw a decline although the trend here has been a good deal firmer.

May producer prices excluding construction surged 1.2 percent and 7.1 percent when compared with last year, their fastest pace since September 1982 (7.3 percent). Energy prices leaped a record 4.1 percent to stand 18.2 percent higher on the year. Omitting this sector reduced the headline monthly increase to a much more reasonable 0.3 percent and the annual growth rate to 3.8 percent. Among other major sectors, only intermediates stood out with a 0.5 percent rise over April. Durable and non-durable consumer goods both edged up just 0.1 percent and capital goods prices rose 0.2 percent on the month.

Germany

May total retail sales edged down 0.3 percent but were up 2.6 percent when compared with last year. Excluding autos and petrol, retail sales volumes rose 1.3 percent for the first increase in three months. On the year, a 0.7 percent gain was solely a function of non-food demand which saw purchases climb a respectable 3.4 percent. In turn this was in large part a reflection of especially strong advances in clothing & shoes (13.9 percent) and, to a markedly lesser extent, furniture & household items (4.1 percent). Food sales were down 3.0 percent.

June unemployment declined by 38,000 which reduced the jobless rate to 7.8 percent from 7.9 percent. The decline in pan-German unemployment reflected drops of 21,000 in the West (to 2,141,000) and 17,000 in the East (to 1,125,000). Moreover, the positive message here was compounded by a 10,000 increase in the number of vacancies that more than offset a 5,000 drop in May. May employment was up by just 3,000 following a 23,000 increase in April.

Italy

May producer prices were up 1.5 percent and 7.5 percent when compared with last year. In April, the PPI was up 0.4 percent and 6.3 percent on the year. The increase reflects a jump in energy prices by 5.8 percent and 21.5 percent on the year. Excluding energy, the PPI was up a benign 0.2 percent and 3.8 percent. In other categories, intermediate goods were 0.5 percent and 4.1 percent higher while consumer goods were up 0.1 percent and 4 percent on the year while capital goods were unchanged on the month and up 2.7 percent on the year.

Asia/Pacific

Japan

Second quarter Tankan survey of businesses confirmed that a slowdown in the economy has taken place since the first quarter. The diffusion index for large manufacturers (the diffusion index showing the percent balance of large manufacturers’ responses on current business conditions) declined to 5 from the March reading of 11 while that for small manufacturers declined to minus 10 from minus 6. Large nonmanufacturers declined to 10 from 12 while small nonmanufacturers declined to minus 20 from minus 15. The reasons behind the depressed sentiment are apparent —deteriorating international terms of trade and uncertainty about the global outlook. Higher energy and material prices along with a decline in export prices due to yen appreciation have eroded profits. Part of this burden has been transferred directly to consumers, for example through higher gasoline prices. However, most of it is being borne by a wide range of business sectors, including small firms that provide services to large exporters, who have become less confident about external demand. But despite a continued uncertainty over global economy and continued high crude oil prices, many companies expect their profits to recover in the second half of fiscal 2008. The survey was conducted from May 28 through June 30.

Australia

May retail sales surprised and were up 0.7 percent and 6.1 percent when compared with last year. April’s sales were revised to a decline of 0.1 percent from the original estimate of a decline of 0.2 percent. Analysts had forecast that sales would decline by 0.3 percent in May. Food retailing was up 1 percent while recreational goods were up 2.2 percent. Other retailing jumped 3.1 percent while hospitality & services gained 0.8 percent. Department stores were down 0.8 percent while soft goods retailing dropped 0.3 percent and household goods retailing declined 1 percent. The data were surprising given that retail sales have borne the brunt of plummeting consumer confidence, tighter financial conditions while higher gasoline, food and dwelling costs have siphoned disposable income away from discretionary expenditures.

April merchandise trade registered a deficit of A$965 million from a surplus of A$12 million in April. The deficit was primarily due to a strong rise in goods and services imports, mainly intermediate and other goods. Exports were up 1 percent. Non-rural and other goods were up A$232 million and rural goods were up A$51 million. Services were up A$32 million. Not surprisingly, the increase in non-rural and other goods was driven by coal, coke and briquettes, which jumped by A$309 million, metal ores & minerals which rose A$233 million and other minerals fuels which rose by A$115 million. Imports soared by 6 percent or A$1,292 million to A$22,836 million. Intermediate and other goods were up A$867 million and consumption goods were up A$386 million, but capital goods fell A$2 million. Services debits edged up by A$41 million. The rise in intermediate and other goods was driven by fuels and lubricants.

Americas

Canada

April real monthly gross domestic product (GDP) was up by 0.4 percent after declining in February and March. On the year, GDP was up 1.2 percent. There were increases in manufacturing, wholesale and retail trade as well as the financial sector, and declines in construction, oil & gas extraction and exploration. During the first quarter of 2008, GDP of the manufacturing, retail and wholesale trade industries was affected by some temporary setbacks in the motor vehicle industry and inclement weather. After two consecutive monthly declines, manufacturing production was up 1.9 percent. Notable rebounds were recorded in the production of motor vehicles as well as in petroleum and some chemical products. Additional momentum came from increased production of machinery & primary metals. Services were up for a second month, gaining 0.4 percent with all but one sector recording a positive gain.

Bottom line

Last week’s economic data illustrated rather graphically how weak output is becoming in the U.S. and Europe. And while the Japanese Tankan showed vulnerability, it was not as weak as some analysts had expected. Equities sank while the U.S. dollar managed to rise in the U.S. holiday shortened week. While the Reserve Bank of Australia kept its key interest rate at 7.25 percent, the European Central Bank increased its key rate by 25 basis points to 4.25 percent.

This week, the Bank of England holds its monthly two day meeting. The Bank is caught between rapidly softening growth and high inflation. Like the ECB, its latest inflation reading is far above its 2 percent inflation target at 3.3 percent.

The leaders of the Group of Eight countries will hold their annual meeting July 7 through July 9 in Hokkaido, Japan. Among the items under discussion is expected to be the fallout from last summer's global credit market meltdown. The subprime mortgage issues in the U.S. are largely under control, but financial market turbulence continues to be a concern, officials said. Leaders are also expected to concentrate on the economic problems brought on by soaring prices for oil and basic food products.

Looking Ahead: July 7 through July 11, 2008

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