Global Markets

Equities were up last week — at least until Friday morning’s U.S. employment. Indexes in the Asia Pacific region — which had ended their trading week prior to the employment release — rallied on improved economic data. The eurozone debt crisis continues to simmer as the EU holds fractious debates on how Greece will receive further bailout funds. Portugal was dragged into the picture again by a Moody’s downgrade which was universally condemned by Portuguese, EU and European Central Bank officials.

The People’s Bank of China increased its policy interest rates midweek, for once not making the announcement on a weekend or holiday. And as universally broadcast, the ECB increased its key rate. Markets shrugged off the PBoC move and rallied after the ECB’s. After raising interest rates as expected by 25 basis points to 1.5 percent, ECB President Jean-Claude Trichet said he would waive the minimum credit rating required for Portugal’s debt to be used as collateral.

Data leading up to the U.S. employment situation report proved to be more optimistic than the report itself, throwing the equity markets in Europe and the U.S. into reverse in Friday trading. On the week, equities in Europe were lower while in the U.S., shares advanced.

Global Stock Market Recap

Europe and the UK

Stocks in Europe swooned Friday and ended the week lower. Equities had been pressured by the ongoing debt crisis and the ECB’s interest rate increase on Thursday. But Friday’s U.S. employment report, which was much weaker than expected, sent shares lower, sealing losses for the week. While the DAX and CAC lost 0.2 percent and 2.3 percent, the FTSE managed to tread water and was unchanged on the week. Bank shares were battered on worries of how they fared in the latest European stress tests. Results from the second round of bank stress tests will be released on July 15^th.

There were two main focal points during the week — the ECB’s expected interest rate increase and the continuing drama surrounding the Greek bailout as negotiations continue to drag on and as the downgrade of Portugal by Moody’s raised the ire of EU and Portuguese officials. Private lenders haggled with officials over the role of the financial sector in a bailout for Greece. In a fresh obstacle as S&P warned that proposals put forward by French banks to roll over some of their Greek debt would likely be considered a selective default under the rating firm's criteria.

On July 2^nd, the eurozone approved its share of a €12 billion aid payment for Greece and pledged to complete work in the coming weeks on a second rescue package. Finance ministers agreed to disburse €8.7 billion of loans under last year’s €110 billion bailout, rewarding Greek Prime Minister George Papandreou for pushing the additional austerity measures through parliament. The spotlight now turns to a second bailout to which banks and insurers plan to contribute following German demands for taxpayer relief. Euro area governments and investors will provide 70 percent of new aid that may total as much as €85 billion with the IMF offering the rest.

Bank of England

As widely anticipated, monetary policy was again left on hold at today's conclusion of the Bank of England’s July monetary policy committee meeting. The Bank Rate remains at 0.5 percent and the QE ceiling at £200 billion. Details of the vote will not be available until the minutes are released on July 20^th but a repeat of June's 7 to 2 majority in favor of steady interest rates and 8 to 1 majority preference for no additional QE seems quite likely.

Since the last deliberations, headline inflation has held steady at 4.5 percent on the year but the core rate eased to 3.3 percent. At the same time, retail sales have fallen sharply and wage growth has decelerated from an already historically soft rate. Moreover, the manufacturing PMI has declined to within shouting distance of its key 50 growth threshold and internationally, the global economy has shown signs of sputtering while the EMU fiscal crisis has deteriorated still further.

European Central Bank

As widely anticipated, the European Central Bank increased its key lending rate by 25 basis points to 1.5 percent. The ECB raised interest rates for the second time in three months on Thursday and signaled a further increase is likely this year to tackle inflation despite the intensifying eurozone debt crisis. The move was essentially pre-warned at its June meeting. In tandem with this, both the deposit and marginal lending rates were also increased by 25 basis points to 0.75 percent and 2.25 percent respectively. By so doing, the ECB retained the 75 basis point corridor either side of the refi rate.

Predictably, the ECB explained its latest move by reference to upside risks to price stability, especially in the context of what it still sees as an accommodative monetary stance. The ECB acknowledged that underlying monetary growth remains relatively subdued, albeit accelerating gradually but it maintains that the current level of liquidity is ample and might facilitate the accommodation of price pressures. As usual the Bank reemphasized its determination to keep inflationary expectations anchored in order to keep possible second round effects in check.

Looking ahead, the monetary authority clearly stands ready to move on rates again as and when it deems appropriate. Certainly the fact that it's prepared to tighten now amid all of the furor surrounding the Greek debt crisis suggests that the eurozone's fiscal problems will not stand in the way. The region's second quarter growth seems unlikely to be impressive but the ECB had already suggested that this was only to be expected and that the underlying picture is somewhat stronger. It sees risks to the economic outlook as broadly balanced.

Pledging to keep providing liquidity regardless of ratings, the ECB offered help to Portugal after ratings agency Moody's downgraded its debt to junk. On Greece's debt troubles, President Jean-Claude Trichet stuck to the bank's view that any rescue should not trigger a default or a payout in credit insurance, a stance that pushes the problem back to the governments.

The ECB has proved a major stumbling block in agreeing to a second rescue plan for Greece as it has threatened to refuse restructured Greek bonds as collateral in its lending operations in the event of a default or a "restricted default," which ratings agencies are threatening to impose. Refusing to accept Greek bonds as collateral would deprive Greek banks of the funds on which they rely, in what would cripple the Greek economy and risk contagion to other euro zone economies. Most economists expect the ECB to baulk at that and keep banks afloat somehow.

Asia Pacific

All equity indexes tracked here were up for a second week. However, this belies the choppy trading that prevailed during the week. First the positive — the Nikkei has made steady improvement since the March 11^th earthquake and tsunami and has hit its highest level since then. This is a symbol of growing belief among investors that the global economic slowdown, partly caused by the tremor and tsunami, is abating. The index ended the week 2.7 percent higher.

On the down side, is China where sentiment towards Chinese banks was hurt by a Moody’s warning that Beijing may have understated the debt load of local governments by $541 billion. However, equities took a People’s Bank of China rate increase in stride. The Shanghai Composite was up 1.4 percent on the week while the Hang Seng advanced 1.5 percent. Investors in this region as elsewhere are keeping a wary eye on the ongoing eurozone debt situation. Elsewhere, the All Ordinaries was 1.5 percent higher as the week ended while the Kospi jumped by 2.6 percent.

People’s Bank of China

The People’s Bank of China increased interest rates for the fifth time in eight months, indicating that the country’s leaders are still focused on taming inflation despite evidence that the world’s second-biggest economy is slowing. The key one year lending rate was raised by 25 basis points to 6.56 percent, while one year deposit rates were raised by 25 basis points to 3.5 percent. The increase suggests that inflation is likely to have accelerated to a three year high of more than 6 percent in June, well beyond China’s comfort zone. The government moved up the release of its inflation data to Saturday, July 9^th (local time) from July 15^th.

Now the debate about interest rates has shifted to whether the PBoC will raise rates again. Although price pressures are still elevated, there has been stress in the domestic money market because of a battery of other tightening measures, including record high bank reserve requirements. Surveys of China’s manufacturing sector last week also pointed to a clear slowdown in industrial activity.

China entered 2011 with an inflation target of 4 percent. Premier Wen Jiabao conceded last month that this goal was out of reach, but added that he believed the government could keep the average rate of inflation below 5 percent.

Reserve Bank of Australia

As expected, the Reserve Bank of Australia left its key interest rate at 4.75 percent where it has been since November 2010. Recent economic data have been on the weak side of late. For example, retail sales dropped 0.6 percent in May and building approvals sank 7.9 percent on the month. There have also been signs that inflation is moderating.

Stevens’ decision to extend a pause in raising rates reflects slowing expansions from Asia to Europe that dimmed prospects for an acceleration in hiring at home by mining companies. Stevens said the European debt crisis had “added to uncertainty” about the outlook for the world economy. In his statement, Governor Glenn Stevens said growth in 2011 is unlikely to be as strong as had been forecast. Australia’s economy contracted 1.2 percent in the first quarter, the most since 1991, as floods in the northeast slashed coal exports. Stevens noted that the gradual recovery from the floods and cyclones over the summer is taking place, though the resumption of coal production in flooded mines continues to proceed more slowly than initially expected.

The RBA has relied on the Australian dollar’s strength to temper inflation. The local currency has risen 27 percent in the past year and reached $1.1012 on May 2, the highest since exchange controls were scrapped in 1983. That appreciation mirrors rising global demand for Australian iron ore, coal and other resources.

Currencies

Despite dropping after the employment report did not meet analysts’ expectations, the U.S. dollar gained against the euro last week. The currency also advanced against the pound sterling and the Canadian and Australian dollars. However, the yen and Swiss franc gained as signs of U.S. weakness spurred demand for a refuge.

The euro was hampered by continuing concerns about eurozone debt. European regulators tried to end the region’s banking crisis by forcing firms to publish details of capital shortfalls in a more stringent and detailed set of stress tests. Lenders will be made to disclose capital levels, estimates for profitability in 2011 and 2012 and their holdings of sovereign debt in the July 15^th test results according to the London based European Banking Authority.

The Canadian dollar was down on the week after the currency weakened on the U.S. payroll employment report. Canada sends about three quarters of its exports to the U.S. Canada’s currency strengthened earlier to touch the highest level since May on Friday after a report showed the nation added more jobs than forecast in June.

Selected currencies — weekly results

Indicator scoreboard

EMU

May producer prices (excluding construction) were down 0.2 percent and were 6.2 percent higher on the year. The May dip was driven by lower energy costs which dropped 1.1 percent from April (but were some 11.9 percent firmer than a year ago). Excluding this sector, prices were up 0.2 percent on the month but this still provided for a moderation in the annual core rate from 4.4 percent last time to 4.2 percent. Elsewhere, prices were steady on the month in capital goods, up 0.1 percent in durable consumer goods, 0.2 percent higher in intermediates and 0.3 percent stronger in nondurable consumer goods.

May retail sales dropped 1.1 percent and were 1.9 percent lower on the year. Average sales in April/May were a disappointing 0.4 percent below their first quarter mean when they contracted 0.2 percent. Excluding fuel, purchases of food, drink & tobacco were off 0.6 percent on the month and 2.1 percent worse on the year while the more important non-food sector saw demand down 0.9 percent from April and 1.9 percent lower than in May 2010. Retail spending was weaker on the month in almost all the reporting members with France 0.7 percent lower, Germany down 2.8 percent and Spain down 1.6 percent.

Germany

May manufacturing orders were up 1.8 percent after a marginally firmer revised 2.9 percent monthly jump in April. The mid-quarter increase left workday adjusted orders up 12.2 percent on the year. The latest improvement was led by capital goods which posted a 2.4 percent monthly rise but basics were not far behind with a 1.6 percent advance. However, consumer & durable goods disappointed with a 1.5 percent drop although this did follow a 4.3 percent leap last time. There was also a marked contrast between the domestic and overseas markets with orders originating from the former up 11.3 percent on the month and from the latter, down 5.8 percent. The weakness of the overall foreign component was roughly evenly split between the eurozone (down 5.4 percent) and non-euro area (down 6.1 percent) and was largely due to a sharp reversal in capital goods (down 8.3 percent). Both basics (down 1.7 percent) and consumer & durables (down 3.0 percent) also lost ground on the month.

May industrial production rebounded 1.2 percent after dropping a slightly steeper revised 0.8 percent in April. On the year, output growth still slipped from 9.3 percent last time to 7.6 percent. The May advance was led by the capital goods sector which more than reversed a 1.1 percent monthly drop in April with a 2.5 percent jump. Production of intermediates was up 0.7 percent but consumer goods output was only flat despite a 0.5 percent gain in durables. The energy sector saw a minimal 0.1 percent increase while a 1.1 percent rise in construction did not come close to offsetting a 5.0 percent slump in April.

May seasonally adjusted merchandise trade surplus widened out from a marginally smaller revised €11.9 billion in April to €12.8 billion. Both exports and imports were up with the former up 4.3 percent on the month and the latter 3.7 percent. Exports were up 19.9 percent on the year while Imports were 15.6 percent above their level in May 2010.

France

May seasonally adjusted merchandise trade gap widened out to a new record of €7.4 billion. The deterioration from a slightly larger revised €7.2 billion shortfall at the start of the quarter reflected a 0.4 percent monthly decline in nominal exports combined with a 0.3 percent rise in imports. The latest increase in the red ink left the average deficit for the first two months of the second quarter at €7.3 billion, up nearly 17 percent from the first quarter mean. The May shortfall compares with a deficit of €5.3 billion in the year ago period and red ink of only €2.6 billion in the same month in 2009.

Italy

May industrial output dropped 0.6 percent following a slightly stronger revised 1.1 percent gain in April. The decline left the level of production just 1.8 percent higher on the year. The May drop was largely due to a 0.9 percent slide in consumer goods although both capital goods (down 0.1 percent) and intermediates (down 0.2 percent) also lost ground. Energy was the best performing sector, up 2.2 percent on the month.

United Kingdom

May industrial production was up 0.9 percent but down 0.8 percent on the year. Manufacturing output was up 1.8 percent on the month and 2.8 percent on the year. April data had been affected by an extended holiday. Within manufacturing, output increased on the month in 11 of 13 sub-sectors and declined in only two. The largest positive contributions were made by machinery & equipment where production jumped 3.8 percent and the other manufacturing industries category which registered a 7.2 percent surge. Basics & metals products (2.9 percent) also fared well. On the downside, the main negative contribution came from coke, refined petrol & nuclear fuels where activity contracted 3.5 percent. Overall industrial production was partly checked by a 5.7 percent monthly slump in oil & gas extraction together with a 5.6 percent drop in its other highly erratic component, mining & quarrying.

June input prices were up 0.4 percent on the month and were 17.0 percent higher on the year. Output prices edged 0.1 percent higher from May and 5.7 percent on the year — its fastest pace since October 2008. Within the monthly rise in output prices the largest gain was posted by paper & printing (0.5 percent) followed by food products (0.4 percent) and the other manufactured goods category (0.3 percent). The only decline occurred in petroleum products (0.1 percent). Core prices climbed a slightly stronger 0.2 percent from May but the annual underlying rate still fell 0.2 percentage points to 3.2 percent. The largest contribution to the monthly rise in input prices came from crude oil where a 0.5 percent advance was worth more than 0.1 percentage points of the headline gain. Other significant increases were seen in imported chemicals (0.9 percent), imported parts & equipment (0.8 percent) and fuel (0.5 percent). Lower prices were registered by both home food materials (0.9 percent) and imported metals (0.3 percent).

Asia/Pacific

Japan

May core private sector machine orders excluding volatile orders (orders for ships and from electric power companies) were up 3.0 percent after dropping 3.3 percent in April. On the year, orders were up 10.8 percent after slipping 0.2 percent in April. Manufacturing orders declined 1.4 percent while nonmanufacturing orders excluding volatile items dropped 5.4 percent. Orders from overseas dropped 6.6 percent after sinking 2.1 percent in April. Core private sector machinery orders are viewed as a leading indicator of corporate capital investment. The Cabinet Office has removed orders for mobile handsets from the core machinery orders figure effective with April data so that the data give a clearer picture of the trend in demand.

Australia

May retail sales dropped 0.6 percent after climbing 1.2 percent in the previous month. On the year, sales were up 2.2 percent. Most sub-categories of sales declined on the month. Other retailing was down 1.6 percent, food retailing edged down 0.4 percent, clothing, footwear & personal accessory retailing decreased by 1.8 percent, department stores declined 1.4 percent and household goods retailing slipped 0.2 percent. Turnover rose in cafes, restaurants & takeaway food services by 0.4 percent. Sales dropped in New South Wales, Victoria, South Australia, the Australian Capital Territory and Tasmania. Queensland was relatively unchanged while sales were up in Western Australia and the Northern Territory.

May seasonally adjusted international balance on goods and services was a surplus of A$2.3 billion, up from a revised A$1.6 billion in April. Exports were up 3.2 percent to A$26.3 billion. Non-monetary gold jumped 49 percent, rural goods were up 6 percent while non-rural goods edged up 1 percent. Imports were up 0.4 percent to A$23.9 billion. Consumption goods were up 4 percent while intermediate and other merchandise goods were up 2 percent. However, capital goods were down 8 percent and non-monetary gold dropped 6 percent.

June seasonally adjusted unemployment rate remained at 4.9 percent for the fourth month. Employment increased by 23,400 to 11,455,200. The increase in employment was driven by an increase in full time employment, which was up by 59,000 to reach a total of 8,082,100 people. This was offset by a decline of 35,600 in part-time employment to 3,373,000. The number unemployed was down by 2,600 to 591,000. The labour force participation rate was 65.6 percent.

Americas

Canada

May industrial product prices declined 0.2 percent on the month and were up 4.5 percent on the year. The monthly decline was led by a 2.8 percent slide in primary metals together with a 0.9 percent drop in petroleum & coal products. Excluding the latter, prices edged 0.1 percent lower from April and were 1.4 percent higher than in the same month last year. The only other declines of note were in lumber & wood (1.6 percent) and meat, fish & dairy products (0.7 percent). Partially offsetting the declines were monthly rises in chemicals & related products (2.1 percent) alongside rubber, leather & plastic (1.0 percent) and motor vehicles & other transport equipment (0.7 percent). May raw material and fuel costs dropped 5.2 percent from April reversing a good deal of their 6.9 percent surge in April. An 8.4 percent drop in mineral fuel charges accounted for much of the headline decline and without this, the RMPI would have fallen only 1.9 percent. Outside of non-metallic minerals where costs were unchanged, all sub-sectors saw costs decline on the month. Ferrous materials (down 3.0 percent) and non-ferrous metals (down 2.3 percent) were especially weak.

June employment was up 28,400 following an unrevised 22,300 gain in May. The participation rate also edged a notch higher to 66.9. The jobless rate was left unchanged at 7.4 percent. Most of the new positions were part time (21,100) while full time jobs expanded a relatively modest 7,300. Private sector payrolls grew 21,900 while the public sector added an unusually large 50,700, probably in part due to temporary census-related hiring. However, self employment declined a hefty 44,200. The goods producing sector created just 3,300 net new positions in June within which manufacturing added 5,300 and construction 2,100. However, gains here were almost offset by a 4,000 decline in utilities. Service sector employment was up by 25,100, including solid advances in transportation & warehousing (14,500) and finance, insurance, real estate & leasing (11,300). Other smaller increases were registered in business, building & other support services (9,100), health care & social assistance (7,600) and information, culture & recreation (6,900). The steepest decline occurred in professional, scientific & technical services (19,200) and headcount was also reduced in trade (2,000) and other services (10,600).

Bottom line

Three scheduled central bank meetings were held and as expected, the European Central Bank increased its policy interest rates. The Reserve Bank of Australia and the Bank of England left policy rates unchanged. However, the People’s Bank of China made an unscheduled announcement increasing its policy rates. Economic data continued to be mixed but more on the positive side with the exception of the U.S. employment report where the results were far below the expected. However, employment was up solidly in Australia and Canada.

The Bank of Japan meets this week and no policy change is anticipated given the positive signs of recovery from the March 11^th disaster. China changed its data release schedule with both the consumer and producer price indexes being released on Saturday morning (July 9) local time with the remainder of its major indicators due on Tuesday. Investors will be reevaluating growth prospects in light of Friday’s dismal U.S. employment report as they continue to monitor the eurozone debt situation. Focus in the U.S. also will be on the debt ceiling negotiations in Washington as the deadline nears. Earnings season begins this week.

Looking Ahead: July 11 through July 15, 2011

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