By Anne D. Picker, Chief Economist, Econoday
Friday, March 23, 2007

Global Markets

The week was divided roughly in half — pre- and post- FOMC announcement. As is usually the case, trading before the Federal Reserve’s announcement was cautious with equities, bonds and the dollar all trading in narrow ranges. However, in the immediate aftermath of the announcement, equities soared, bonds rose and the dollar sank, especially against the euro. Markets in Europe and Asia were closed at the time of the announcement so investors had to wait until Thursday to follow U.S. investors. Second thoughts began to pervade investor thinking on Thursday and into Friday though, as analysts continued to parse the FOMC statement. On the week, all equity indexes followed here were up. All except the Hang Seng regained a positive increase for 2007.

Global Stock Market Recap

Europe and the UK

Equities staged a comeback last week as merger and acquisition news enticed investors to buy. The tendency of European indexes to follow U.S. index behavior was very visible Thursday, when the CAC, DAX and FTSE rallied on news that the FOMC had removed a key phrase from their post meeting statement. It no longer included a specific reference to further interest rate increases. But profits on share prices looked good and investors began to sell on Friday, although not enough to change the positive outcome for the week. A positive U.S. housing report helped boost the three indexes into the plus column on Friday as well. In Europe, auto stocks were invigorated on signs that DaimlerChrysler AG is moving closer to selling its Chrysler unit.

The FTSE gained and the pound sterling dropped when Chancellor of the Exchequer Gordon Brown announced an income and corporate tax cut in last week’s budget message. The message was probably his last budget prior to taking over as prime minister in the next several months. The basic income tax rate will be reduced to 20 percent from 22 percent and company taxes will be 2 percent lower. The measures are the biggest tax reductions since 1999 and are designed to benefit middle-income families and bolster the Labour government's sagging popularity.

Bank of England minutes reveal inflation concerns

With one dissenting vote, the monetary policy committee members said they had concerns about inflation risks in the medium term even though one of their primary concerns, risks stemming from wage growth, had not yet materialized. These concerns were confirmed two weeks after the meeting when the latest consumer price data were released — they showed a rebound in both core and overall prices. David Blanchflower, the lone dissenter, called for an immediate quarter point cut. Sterling declined as traders digested the dovish tone to the minutes. However, it soon bounced back as economists calculated that although the vote may suggest another interest rate rise isn't imminent, a move to 5.5 percent before the summer is still likely.

Asia/Pacific

Asian Pacific equity indexes continued to recover from last month’s sell off. The outlook for the U.S. economy has swayed from optimism to pessimism and back again. And Wednesday’s FOMC decision and statement, which was followed by an exuberant rally in U.S. stocks, sparked the rally in Asia. Stocks in Tokyo and Hong Kong closed at three-week highs. In Shanghai, where a 9 percent slide on February 27 helped precipitate the worldwide rout, the index ended at a fresh all-time high. In Japan, banks along with companies that rely on domestic growth led gains after land prices rose for the first time in 16 years. Property prices rose nationwide an average 0.4 percent in 2006 according to the Ministry of Land, Infrastructure and Transport. Commercial land prices climbed 2.3 percent and residential prices gained 0.1 percent.

Hong Kong Hang Seng climbed to its best level since last month's end. Interest rate-sensitive property stocks led the way. Hong Kong’s currency is pegged to the U.S. dollar and rate changes are passed on by the Hong Kong Currency Authority. Not surprisingly, the interest rate sensitive property sub-index rose 2.7 percent.

Bank of Japan — no change

The Bank of Japan held a regularly scheduled meeting of its monetary policy board on Monday and Tuesday. As expected, no policy change was made. The Bank’s key interest rate remained at 0.5 percent. The Bank ended its zero interest rate policy in July 2006 when the board increased its rate to 0.25 percent. The Bank increased rates a second time in February 2007 when it raised its key rate to 0.5 percent.

People’s Bank of China — a rare rate increase

People’s Bank of China increased its policy interest rate by 27 basis points to 6.39 percent. This was the first interest rate change since August 2006. The previous interest rate increase (also by 27 basis points) was in August 2006. In its statement, the PBoC said that the rate change had various goals including “leading a reasonable growth of credit and investment, maintaining basic stability of prices, steady and healthy operation of the financial system, balanced economic development and structure optimization, as well as promoting the national economy to develop both well and fast.” China only reluctantly adjusts base interest rates — more frequently authorities pressure state-controlled banks or make technical adjustments to their capital requirements.

Currencies

The U.S. dollar bounced back from a two-year low against the euro after dropping on Wednesday when the FOMC kept its policy rate at 5.25 percent and softened its tightening bias in its post-meeting statement. The U.S. currency was bolstered further on Friday after existing home sales increased more than expected. The dollar regained all of the week’s losses, at least against the yen and euro where it posted gains. But the dollar lost ground against both the Canadian and Australian dollars and was virtually unchanged against the pound sterling.

The Australian dollar surged to the strongest since 1996 as traders increased bets the central bank will increase interest rates from the current six-year high of 6.25 percent. A rate increase could encourage investors to buy the nation's higher-yielding assets with money borrowed more cheaply in Japan. The currency has climbed more than 1.2 percent since March 16, after Reserve Bank of Australia Assistant Governor Malcolm Edey said inflation was too fast and suggested interest rates would rise. The current spread between the RBA policy rate and the U.S. and the UK is 1 percent and 1.5 percent with the ECB.

Indicator scoreboard

EMU — January unadjusted merchandise trade deficit was €7.8 billion, reversing December’s surplus of €3.2 billion and then some. The January 2006 deficit was €9.9 billion. The data include Slovenia for the first time. The country became part of the EMU on January 1, 2007. On a seasonally adjusted basis, the merchandise trade surplus was €1.3 billion, down from December’s surplus of €2 billion.

Germany — February producer price index was up 0.2 percent and 2.8 percent when compared with last year. After dropping 2.1 percent in January, petroleum product prices jumped 1.5 percent in February. Excluding energy, the PPI was up 0.3 percent and 3 percent on the year. Capital goods prices edged up 0.1 percent and consumer goods, 0.2 percent.

France — February consumer spending on manufactured goods dipped 0.4 percent but was up 5 percent when compared with the same month a year ago. Home entertainment & computer systems and appliances & furniture were down 1.6 percent but are up 20.4 percent on the year. Other manufactured goods (including cosmetics, drugs, car parts, jewelry, photo and sporting goods) were down 0.5 percent but up 0.3 percent on the year. Offsetting some of the decline were auto sales, which were up 0.8 percent on the month, and clothing expenditures which were up 0.4 percent.

Italy — Fourth quarter unemployment rate dropped to 6.5 percent from 6.7 percent in the third quarter. This is the lowest level since before the series began in 1992. Joblessness has declined steadily since 2000 as changes to labor laws have made it easier to hire part-time and temporary labor and efforts to legalize immigrants have led to more workers emerging from the black economy.

United Kingdom — February consumer price index was up 0.4 percent and 2.8 percent when compared with last year. The jump in the index was partly due to the increase in the Air Passenger Duty and higher non-seasonal food prices. Core CPI which excludes energy, food, alcoholic beverages and tobacco was up 0.4 percent and 1.7 percent on the year. The Bank of England uses the CPI as its measure of inflation. The current inflation target is 2 percent. The retail price index excluding mortgage interest payments was up 0.5 percent and 3.7 percent on the year. The RPIX was the Bank’s old inflation target and is currently used as a benchmark for just about everything except monetary policy.

February retail sales were up 1.4 percent and 4.9 percent when compared with last year. The monthly increase virtually erased January’s 1.5 percent decline. Food sales were flat on the month while non-food sales jumped by 2.6 percent. Clothing and footwear sales soared by 4.7 percent.

Asia

Japan — February unadjusted merchandise trade surplus was up 7.7 percent to ¥979.6 billion when compared with the same month a year earlier. Exports climbed 9.7 percent while imports were up 10.1 percent on the year. Exports to the U.S. were up 7 percent, accelerating from 5.5 percent growth in January, thanks to demand for Japanese automobiles. On a seasonally adjusted basis, February merchandise trade surplus dropped to ¥655 billion from ¥1.1 trillion in January. Exports were down 2.3 percent while imports were up 4.1 percent. Data for January and February are typically affected by the Lunar New Year which cuts short the number of business days in China and other countries that observe the holiday.

January all industry index was up 0.7 percent and 1.0 percent when compared with January of 2006. The all-industries index is considered a close approximation for gross domestic product growth as measured by industrial and service sector output. The index takes a reading of activity in the 11 industries that comprise the tertiary index (which was released last week) combined with activity in the construction, agricultural and fisheries industries, the public sector and industrial output.

Americas

Canada — February consumer price index was up 0.7 percent and 2 percent when compared with last year. The increase was mainly due to higher gasoline and housing prices. Excluding energy, the CPI was up 0.6 percent and 2.2 percent on the year. Core CPI was up 0.4 percent and 1.8 percent on the year. The Bank of Canada core CPI which excludes eight of the most volatile components was up 0.5 percent and 2.4 percent on the year. The Bank has an inflation target range of 1 percent to 3 percent and focuses on the mid-point of 2 percent.

January retail sales dipped 0.2 percent after soaring 1.9 percent in December. Sales were up 4.9 percent when compared with January of 2006. Excluding autos only, retail sales were up 0.3 percent and up 4.7 percent on the year. Excluding the overall automotive sector including gasoline, retail sales were up 0.9 percent. Automotive sector sales dropped 2.4 percent, which reflects a 3.5 percent drop in gasoline station sales due to lower prices. Furniture, home furnishings & electronics sales were up a robust 2.1 percent while clothing & accessories were up 1.6 percent.

Bottom line

New economic data were on the light side last week and investors were able to focus on the Federal Reserve’s two-day policy meeting. While no one expected a change in the 5.25 percent target federal funds rate, interest centered on the FOMC statement. Moving towards a more "neutral" monetary policy, the Fed, by omitting reference to “additional firming,” raised expectations that the next move may be an interest rate cut. Stocks and bonds rallied while the dollar sank against all major currencies. The Bank of Japan kept its monetary policy unchanged and assured legislators that they would make changes at a very slow pace. The People’s Bank of China, however, increased their policy rate — something they do very rarely.

Last week’s absence of new data will be more than compensated for this week. There is a full agenda of releases in the U.S., Europe and Japan. In Japan, especially, this week brings new data on inflation, consumer spending and industrial production. It is the last week of the Japanese fiscal year. And on Sunday, Europe and the UK begin summer time while Australia reverts to standard time. 

Looking Ahead: March 26 through March 30, 2007

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

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