Global Markets

The common themes in last week’s economic releases were weakness and higher inflation. Although the pickings were slim, producer price inflation data from the Germany and the U.S. pointed to continuing price pressures. And merchandise trade data especially from the eurozone and Japan pointed to weaker trade prospects thanks to slower demand growth worldwide. And in Europe, the flash PMI manufacturing and services indexes were below the breakeven point of 50, pointing to contraction.

With volumes thin as summer wanes, stocks were volatile as those investors still trading had second thoughts about assuming risk as political and weather worries swirled around crude oil supplies and prices. The thin volumes occurred against a background of continuing bad news from the credit and money markets. Persistent concerns about the outlook for the global financial sector and the U.S. government sponsored companies Fannie Mae and Freddie Mac in particular sent investors running for cover. And continued concerns about the health and wellbeing of Lehman Brothers continued to unsettle equity investors as they focused on the chances of a foreign investor taking a stake in the U.S. investment bank. And a sharp rally in oil prices unsettled equity investors and helped push the dollar sharply lower on Thursday.

Few indexes were up on the week. In the Asia/Pacific region, only the Indonesian Jakarta Composite was up. In Europe, the UK FTSE was the star performer while in North America, only the Canadian S&P/TSX Composite managed a positive week.

Global Stock Market Recap

Europe and the UK

Stocks rebounded Friday and cut into trading losses that occurred during the week. The FTSE vaulted into a positive close for the day and week in pre-holiday trading. Investors threw aside their risk averse positions at least for Friday as they speculated that takeovers might increase while a drop in oil prices boosted airlines and carmakers. Most of the prospective takeover activity swirled around Lehman Brothers, the ailing U.S. investment house after the Korea Development Bank said it was considering an investment in the firm.

The FTSE was up 0.9 percent on the week, helped by better than expected retail sales but relatively unaffected by Friday’s downward revision of second quarter GDP. However, the CAC and DAX had too much to make up and were down for the week. Some analysts said that European takeovers have drawn a “line in the sand” for asset valuations and represent a turning point for the market. Crude oil and other commodities prices along with political uncertainties continue to impact the direction of stock trading as escalating tensions with Russia stoked fears of supply disruptions to the West.

Recent European economic data continue to be weak. The advance readings of the purchasing managers’ indexes for example, suggest that the eurozone remains on the brink of recession. But at the same time, the surveys pointed to easing price pressures thanks to declining commodity prices.

Bank of England minutes — a vote split once again

The Bank of England’s monetary policy committee decided to keep their key interest rate on hold at 5 percent at their August meeting despite inflationary pressures. Rather, the rate was unchanged because of economic weakness. Although members thought the balance of risks to inflation was on the upside, the main question before the group was whether the economy would become sufficiently slack for inflation to be subdued of its own accord. The minutes suggest that the decision to hold rates steady was finely balanced and that an impending interest rate cut that market participants read into the Bank’s recently released Inflation Report may have been premature. For a second month, five members of the committee voted to hold rates steady while one voted to increase rates and another voted for a decrease.

The committee noted that bank funding remains constrained and that many institutions are planning to reduce their lending in the months ahead. Further capital raising by banks could prove more problematic than those held so far, and that, in turn, is likely to constrain lending even more. The MPC also noted that while inflation was well above its 2 percent inflation target, recent developments in oil and commodities prices offered some hope that costs pressures may ease. Moreover, there appeared little scope for wage rises as a weakening labor market acts as a brake on pay demands.

Asia/Pacific

Asian/Pacific equities drooped once again last week as the summer stumbled to a close. Markets were thin as investors preferred to vacation rather than watch their equities’ values erode. Only stocks in Indonesia managed to gain on the week. The South Korean Kospi was down — falling below the 1,500 mark for the first time in 16 months. Investor concerns in the region were many. Worries that the West will fall into recession and slow exports combined with concerns that Russian and Caspian Sea supplies may be disrupted were foremost on investors’ fears. Compounding these worries were fears that the U.S. government would have to bail out the mortgage finance companies Fannie Mae and Freddie Mac weighed on financial stocks.

In Japan, the Bank of Japan met and left its policy interest rate unchanged at 0.5 percent. The first estimate of gross domestic product (which was released August 13^th) did not surprise — the economy contracted on the quarter for the first time since the fourth quarter of 2004. Japanese stocks were down four of five days last week as a stronger yen weighed on exporters. As if to emphasize exporters’ woes, July’s preliminary merchandise trade balance plummeted 86.8 percent on the year to ¥91.1 billion and the fifth straight month of decline.

The Nikkei lost 2.7 percent while the Topix was down 2.5 percent on the week. The minutes for the BoJ’s July 14 and July 15 meeting noted that the U.S. economic slowdown and heightened instability in equity markets have increased the downside risks to Japan's economy. The central bank added that attention should be paid to the degree of overseas growth deceleration. A number of members expressed concerns about the risks of the nation's loose monetary policy and said that those risks should be monitored closely.

Bank of Japan — no where to go

As anticipated, the Bank of Japan kept its policy interest rate at 0.5 percent despite a continuing flow of bad economic news. The most recent was the decline of 0.6 percent in second quarter GDP and puts the economy on the brink of a technical recession for the first time in six years. But at the same time, the monetary policy board now has to contend with rising inflation, a phenomenon unknown in Japan for several years until recently. Although inflation is confined to imported fuel and foods, eroding profits are discouraging companies from increasing investment and wages. The BoJ has the lowest interest rate level in the industrialized world. The GDP data showed that exports declined the most since the 2001 to 2002 recession, robbing Japan of its engine of growth.

In his post meeting press conference, governor Masaaki Shirakawa said that economic growth has been sluggish against the backdrop of high energy and materials prices and weaker growth in exports. World financial market instability, the U.S. and global slowdown and rising commodity prices all posed risks for Japan. The Bank's downgrade of the economic assessment was the second in a row, after it said that the expansion was slowing further in the previous month. However, according to Shirakawa, the chances of a major deterioration are small. However, he added, “the timing of a recovery may be slightly delayed.” Costlier materials and slumping overseas sales are crimping exporters’ profits. “If the downside risks to the economy turn out to decrease, there will be an increased risk that prolonging the period of accommodative financial conditions will lead to swings in economic activity and prices.”

Governor Shirakawa, after only four months on the job, is making one of the world's most opaque major central banks more transparent. For example, when the monetary policy board left its key interest rate unchanged at 0.5 percent, they listed the reasons for the decision. Until July, they said nothing when they held rates steady. The Bank also is increasing the number of forecasts it publishes and instead of just signaling the direction of borrowing costs during his post-meeting press conferences, Shirakawa is trying to explain his thinking about the economy. The changes bring the BoJ into line with moves worldwide to help outsiders better understand how decisions are reached.

Currencies

The dollar’s rally ran out of steam after the previous week’s run up as some traders thought the dollar had appreciated too much and too fast. The dollar settled back as investors took profits. Some analysts thought that the dollar’s retreat was due to new worries over the health of the U.S. financial system, while rising oil prices amid escalating tensions between NATO and Russia were also cited as a reason for the dollar’s performance. Currencies continue to fluctuate with crude oil and other commodity prices. Analysts said the dollar continued to benefit from a growing conviction that the effects of the credit crisis were spreading across economies outside the U.S. more strongly than previously thought. And economic data outside the U.S. was looking more and more unpleasant.

Sterling was down against the dollar and euro especially after UK GDP was revised downward to no change in the second quarter.

Selected currencies — weekly results

Indicator scoreboard

EMU

June seasonally adjusted merchandise trade deficit was €3.0 billion. Exports were up 1.4 percent but imports jumped by 2.9 percent and more than offset the increased exports. The unadjusted trade deficit was €120 million. On the year unadjusted exports were up 5 percent while imports were up 11 percent. For the first six months of 2008, the shortfall on net energy exports was €124.5 billion, up €35.5 billion from the same period of 2007. Over the same period, the surplus on manufactures actually grew significantly, to €118.7 billion from €96.4 billion with the black ink on machinery and vehicles expanding by almost €10 billion.

Germany

July producer price index was up 2 percent and 8.9 percent — a 27 year high — when compared with last year. Energy prices were the main culprit once again. Monthly increases in heavy heating oil (19.7 percent), light heating oil (1.9 percent), liquid gas (4.6 percent) and electricity (5.7 percent) together ensured a rise in total energy prices of 5.1 percent on the month or 24.5 percent on the year. Excluding this category, prices were up an annual 3.6 percent, although even this was faster than the 3.0 percent pace posted last time.

August ZEW expectations edged up from minus 63.9 to minus 55.5. However current conditions sank from 17 to minus 9.2 in August. The tentative improvement in the forward looking index probably reflects the partial recovery of the dollar and the recent slippage in oil prices. However, the August level compares with its historical average of 28.3 and so continues to signal a difficult second half of the year for German industry. The survey is not calling for a German recession but the nosedive in the current conditions measure is testimony to how sharply the economy has deteriorated.

United Kingdom

July retail sales were up 0.8 percent after sinking a record 4.3 percent in June. On the year, sales were up 2.1 percent. Most of the latest advance was attributable to non-food stores where volumes were up 1.3 percent on the month, easily eclipsing a 0.3 percent rise in food purchases. Within this former group, there were solid gains in clothing & footwear (1.5 percent), household goods (1.6 percent) and other stores (2.8 percent). Increases here were only partially offset by declines at non-specialized stores (2.6 percent) and non-store retailing (0.1 percent). There was a disappointingly large jump in the retail sales deflator which posted annual growth of 1.6 percent, up from 0.6 percent in June and its fastest pace since May 1998. This was mainly a function of soaring food costs which were up some 6.1 percent on the year.

Second quarter gross domestic product was revised downward to show no change on the quarter from the original 0.2 percent gain. This was the weakest quarterly performance in six years and reduced annual growth to 1.4 percent from the originally estimated 1.6 percent gain. By sector, household expenditures slipped 0.1 percent on the quarter, reflecting a broad-based retrenchment and constituted the poorest outcome since 2005. Even worse, fixed capital formation slumped 5.3 percent and now stands down 2.1 percent on the year. Government spending rose 0.4 percent from the first quarter and the bottom line was flattered by a 0.4 percentage point contribution from net exports. Total domestic expenditure actually shrunk 0.3 percent on the quarter and rose 1.7 percent on the year. By output sectors, industrial production dropped 0.8 percent from the previous period with manufacturing matching the headline fall. Service sector activity grew 0.2 percent but construction fell 1.1 percent and agriculture, forestry & fishing slipped 0.2 percent.

Asia/Pacific

Japan

June all industry index was down 0.9 percent on the month and declined 1.2 percent on the year. The tertiary index which is a major component of the all industry index declined by 0.8 percent in June. The all industry index takes a reading of activity in the 11 service industries that comprise the tertiary index, along with activity in the construction, agricultural & fisheries industries, the public sector and industrial output. This index is considered a close approximation of gross domestic product growth as measured by industrial and service sector output.

July seasonally adjusted merchandise trade surplus was ¥172.4 billion and up from June’s revised surplus of ¥131.3 billion. The unadjusted merchandise trade surplus was ¥91.1 billion, down 86.6 percent from the same month a year ago. Exports were up 8.1 percent while imports shot up 18.2 percent on the year thanks primarily to mineral fuels. Exports to the United States were down 11.5 percent while imports from the U.S. declined by 3.5 percent on the year. Exports, however, to the EU were up 4.1 percent while imports from that area declined 6.3 percent. Both exports and imports with Asia continue to climb. Exports gained 12.7 percent while imports were up 5.7 percent on the year. All major categories of exports were up on the year although their components were mixed. For example, machinery was up 3.7 percent while electrical machinery was up 2.2 percent. Transportation equipment which includes the all important automotive sector was up 7.8 percent. However, on the import side, the major categories were mixed. Both machinery and electrical machinery were down 5.9 percent and 6.0 percent respectively as was transport equipment which declined 5.3 percent on the year. However foodstuffs increased 18.2 percent and mineral fuels soared 69.9 percent on the year.

Hong Kong

July consumer price index was up 6.3 percent when compared with last year. Food prices and rental costs continued to be the main factors behind the elevated figure. Excluding food and housing, core CPI was up 2.7 percent on the year and reflects higher costs of transportation and utilities thanks to elevated global energy and commodity prices.

Taiwan

Second quarter gross domestic product was up 4.32 percent from a year ago and down from the first quarter's 6.25 percent gain. Seasonally adjusted GDP was up at an annualized rate of 1.3 percent when compared with the first quarter. The report showed broad-based slowing across the major external and domestic sectors. Gross fixed investment dropped by 25.0 percent SAAR while private consumption demand eased further, edging down by 0.3 percent on the quarter SAAR.

Americas

Canada

June retail sales were up 0.5 percent and 4 percent when compared with last year. However when adjusted for higher prices, retail sales would have declined by 0.4 percent on the month. Within total cash sales, the automotive sector edged down 0.1 percent on the month despite a 4.2 percent jump at gasoline stations for a fifth consecutive monthly decline in the sector. There were also declines at both new car dealers (3.1 percent) and used auto sellers (0.8 percent). Other sectors fared rather better, however, although most gains were quite modest. Furniture, home furnishings & electronic stores (0.5 percent), building & outdoor home supplies (0.7 percent) and food & beverage stores (1.3 percent) were up and there was a sizeable jump in purchases of clothing & accessories (2.5 percent). Excluding the auto sector, retail sales were up 1.4 percent from May and 6.8 percent on the year.

July unadjusted consumer price index was up 0.3 percent and 3.4 percent when compared with last year. Core CPI excluding just food and energy was up 0.1 percent on the month and just 1.2 percent on the year. The Bank of Canada core CPI which excludes eight volatile items edged up 0.1 percent and was up 1.5 percent on the year. The monthly increase in the overall CPI was led once again by energy (2.3 percent). The other main contributors were food (0.6 percent), shelter (0.8 percent) and clothing & footwear (0.9 percent). Prices in the goods producing sector rose 0.4 percent on the month for a 3.2 percent annual rate while in services, prices climbed 0.3 percent from June to give an annual inflation rate of 3.6 percent.

Bottom line

New data were sparse last week. U.S. and German producer price inflation soared while the Japanese trade surplus continued to dwindle downward. Trading volumes were thin as market participants focused on the end of summer vacation time. As to be expected, trading was volatile. Those investors left in town fretted over the health of the U.S. financial system and waning growth in Europe and the UK.

Last week’s slim economic news will be more than offset by this week’s deluge. It is the last week of the official summer season and the end of trading for August. Revised estimates of German and U.S. GDP will be released along with Canadian growth data. And in Japan, the usual deluge of consumer spending, labour force and industrial production data will help pinpoint the status of some troublesome areas within the economy. It is a shortened trading week in the UK while the U.S. will be looking forward to the Labor Day break.

Looking Ahead: August 25 through August 29, 2008

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