By Anne D. Picker, International Economist,Econoday
Monday, April 8, 2002

Investors were nervous last week for a variety of reasons. Earnings season is arriving and companies, in the post-Enron era of fastidious accounting, have become more cautious in stating profits. Investors also are worried that central bankers may raise interest rates as growth and inflationary pressures accelerate, which could hurt profits. Middle East warfare and the specter of a possible curtailment of oil supplies rattled market players. Not surprisingly, most of the equities indexes followed here were down on the week with the exception of the South Korean Kospi, which continued its stellar performance. The Japanese Nikkei and Topix also were higher as government pension funds poured newly available funds into stocks.

Crude oil futures rose for a combination of reasons, one of which is stronger demand thanks to positive growth coupled with the onset of the spring driving season. But the unstable political situation in the Middle East also put upward pressure on prices. In reality, oil exporters need the revenue stream from oil sales and would not shutoff production even should the worst happen. Non-OPEC members have indicated that they would step into any supply breach. This has been a volatile time for oil prices. In just over three years the price has gone from about $10 a barrel to $37, back down to $17 and back up to $27. Why is oil so volatile? Supply and demand are thinly balanced, so small changes in either can have a disproportionate effect on prices. Will the rise in prices hit the recovery? The volatility is partly due to that recovery, partly to Middle East tension. But at present levels the price of oil does not pose much danger; unless of course it retraces its steps back to $37 a barrel.

All three central banks that met last week left their key interest rates unchanged. The Reserve Bank of Australia left its bank rate at 4.25 percent. The Bank of England's key interest rate is 4 percent while the European Central Bank's is 3.25 percent. Analysts expect that rates will remain on hold for the next several months until growth and/or inflation show signs of accelerating. The ECB, with its two percent inflation ceiling, is particularly zealous in watching price trends. The last oil price increase fed through to fuel European inflation. Ironically, the harmonized index of consumer prices, their inflation gauge, which is currently at 2.5 percent, has not been below the two percent target since May 2000 thanks in large part to crude oil prices. The Bank of England uses an inflation target of 2.5 percent. The retail price index excluding mortgage interest payments had remained under the target rate but popped above the 2.5 percent level in January. It immediately receded below the critical value in February.

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