By Anne D. Picker, International Economist,Econoday
Monday, August 13, 2001

The dog days of summer are upon us. And as investors fled the heat for cooler vacation spots, light trading volumes translated into increased market volatility. All indexes tracked here were down last week, depressed once again by the interminable string of disappointing earnings reports. There was little in the way of positive economic news to cheer up market players. Investors worldwide reacted negatively to the latest Federal Reserve Beige Book and bashed stocks and the dollar. The report said that manufacturing sluggishness had spread to the rest of the economy. Investors are still looking for the white knight to lead world economies out of the gloom that has overtaken them.

The Bank of England issued its quarterly Inflation Report and the European Central Bank issued its monthly report. The Bank of England said that the medium term outlook for both inflation and growth had weakened since their last report in May. The principal downside influences were the more subdued outlook for the world economy and for domestic capital spending, together with the weaker import prices. It was noted that the recent higher level of retail price index excluding mortgages (RPIX), their inflation gauge, had not been expected but was due mainly to a temporary pick up in seasonal food prices. The BOE said that growth had slowed more sharply than projected three months ago. The near term outlook was also seen as weaker, reflecting the slowdown in the world economy, lower demand for capital goods, and pressure on firms to reduce inventories. Although the BOE continues to see the outlook for the U.S. economy as one of the major risks to its projections, the report emphasized that a key factor behind the August 2 interest rate cut was the slowdown in euro area activity.

The European Central Bank warned that the risks to economic growth would remain sizeable during the rest of this year. The ECB pointed to problems elsewhere in the world economy and to the recent weaker than expected economic data. The bank highlighted the potential impact of changes in confidence on domestic demand as a factor to watch. The ECB said its current stance on interest rates was "appropriate" but added "there is a need to monitor closely developments that may affect this assessment". Analysts said the wording suggested a change of heart and the ECB would lower interest rates soon.

The U.S. Federal Reserve has lowered interest rates six times this year. The Bank of England has pared borrowing costs four times, and the Bank of Japan is holding the cost of money near zero. The ECB hasn't cut rates more because inflation has exceeded its goal of keeping consumer price increases below 2 percent for more than a year. Inflation fell to 3 percent in June from 3.4 percent the previous month, and German and Italian reports suggest it fell further in July.

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