Global Markets

With investors focused on the outcome of the EU summit, little else could attract their attention. Europe secured an historic agreement to draft a new treaty for deeper economic integration in the Eurozone, but Britain, the region's third largest economy, refused to join the other 26 countries in attempting a new fiscal union. This leaves the UK, at least for now, isolated as the rest of the European Union agreed to press ahead with new fiscal rules to balance budgets. The key point here though is that rather than the agreement being enshrined in the EU, it is a separate treaty because there was not unanimous approval.

But a new treaty will take weeks of wrangling as countries like Finland and Slovakia oppose a Franco-German drive to allow an 85 percent majority to determine passage of future bailouts instead of the unanimous agreement required now, a move aimed at reducing the power of small countries. A new treaty may require risky referendums in countries such as Ireland. Nine other countries have said they will sign up, some pending consultations with their parliaments. Hungary originally said it would also remain outside the deal but has now changed its stance. The UK effectively used its veto to block an attempt, led by the French and Germans, to get all 27 EU states to support changes to the union's treaties.

The proposal, which has yet to be fleshed out, would impose “automatic consequences” for countries whose public deficit exceeds 3 percent of gross domestic product and would cap countries’ structural deficits at 0.5 percent. The tighter rules will be written into national constitutions. The 17 countries of the Eurozone signed up to the new agreement after all night talks, with nine other countries including Denmark, Sweden and Hungary agreeing to consider joining after consulting their national parliaments. However, some countries — such as the Republic of Ireland which is in the eurozone — have a constitutional requirement to hold a referendum on any major transfer of powers to the EU.

Without agreement among all 27 EU member countries, it remained unclear how the new fiscal rules the summit leaders promised to follow would be enforced. EU institutions — most importantly the European Commission which oversees and passes judgment on such rules in Brussels — legally cannot have a formal role in any agreement outside the EU treaties.

Below are the key points which will be agreed to inter-governmentally and outside the judicial and institutional framework of the EU —

• a cap of 0.5 percent of GDP on countries' annual structural deficits
• automatic consequences for countries whose public deficit exceeds 3 percent of GDP
• the tighter rules to be enshrined in countries' constitutions
• the EU's permanent bailout facility — the European Stability Mechanism (ESM) — to be accelerated and brought into force in July 2012
• the adequacy of the €500 billion limit for the ESM to be reassessed
• Eurozone and other EU countries to provide up to €200 billion to the International Monetary Fund (IMF) to help debt-stricken Eurozone members

Britain refused to allow its partners to amend the EU treaty, demanding guarantees in a protocol that would protect its financial services industry, roughly 10 percent of the country's economy. Sarkozy described Cameron's demand as unacceptable.

Global Stock Market Recap

Europe and the UK

Equities were mixed last week as investors focused on the buildup to the EU summit on Thursday and Friday and the European Central Bank announcement that preceded it. The indexes pared losses incurred earlier in the week with the CAC and SMI advancing 0.2 percent and 1.3 percent respectively while the FTSE and DAX were 0.4 percent and 1.5 percent lower. In addition to the EU agreement, a Reuters report said China will create a new investment vehicle to improve returns on its foreign-exchange reserves. The vehicle will operate one fund targeting investment in the U.S. and another focused on Europe.

European stocks dropped during the week as the ECB dampened speculation it would step up purchases of government bonds and regulators said lenders need to raise more capital than previously forecast. Adding pressure earlier in the week to reach an agreement, S&P put 15 Eurozone countries on negative credit watch, including the six triple-A-rated governments of Germany, France, the Netherlands, Austria, Finland and Luxembourg. S&P also placed the long term credit rating of the European Financial Stability Facility, or EFSF, on credit watch negative. The move puts the bailout fund's rating on review for a possible downgrade.

Bank of England

The Bank of England as expected left its benchmark interest rate at a record low of 0.5 percent where it has been since March 2009 after governor Mervyn King warned of growing risks for Britain’s economy from the euro area. It also left its bond purchasing target unchanged at £275 billion. Some economists expect the Bank of England to expand its asset buying program further next year to help avoid a credit crunch.

The Bank of England kept interest rates low despite inflation at 5 percent in October, well above its 2 percent target rate, as consumer confidence dropped and concerns about the debt crisis in the euro countries rose. Britain is a member of the European Union but not a member of the Eurozone. Inflation is expected to drop next year as the headwinds for the economy pick up. The bank cut its economic growth forecast for 2012 by half to 1 percent last month.

European Central Bank

As expected the ECB cut its key interest rate by 25 basis points for the second time in as many months to 1.0 percent. The latest move means that the benchmark rate, having previously been increased in two stages to 1.5 percent, is now back at the level during the recession. The corridor surrounding the refinance rate was adjusted similarly putting the rates on the deposit and marginal lending facility at 0.25 percent and 1.75 percent respectively. In more normal times the spread between the two would be 200 basis points but, for now at least, the monetary authority appears to be in no hurry to restore the gap.

Today's decision took place against the backdrop of a two day EU leaders' summit that, in many ways, will determine the fate of the euro. By loosening its policy stance again, the ECB may claim to have played its part in trying to calm Eurozone financial markets and at least it has responded, albeit belatedly, to the increasing risk of a Eurozone recession. The ECB has revised down its 2012 GDP growth forecast from a range of 0.4 percent to 2.2 percent to just minus 0.4 percent to 1.0 percent. However, the Bank clearly sees substantial downside risks and to this end, also opted to expand its portfolio of non-standard policy measures.

The ECB said there will be two additional long term repos tenders ((LTROs) with a 36-month maturity and an option of early repayment after one year. These will entail fixed rate tenders and full allotment, the first starting on December 21. Furthermore, there will be an increase in collateral availability by reducing the rating threshold for certain asset backed securities (ABS). Thirdly, the ECB announced a reduction in the reserve ratio from 2 percent to 1 percent, beginning January 18, 2012. And lastly there will be some fine tuning measures concerning the last day maintenance period but these can be seen as essentially technical.

Asia Pacific

Most equities in this region declined last week, giving back a portion of the previous week’s hefty gains. The declines reflected the unease about the outcome of the EU summit which continued after markets here were closed for the week. Relatively weak Chinese November data also weighed on investors. Thursday’s ECB policy announcement fell short of investor expectations and dampened expectations for the summit. As expected, the European Central Bank lowered its benchmark interest rate by 25 basis points, but President Mario Draghi downplayed expectations for a massive bond buying program, insisting that the Eurozone's existing bailout facility should remain the main tool to fight bond market contagion.

Losses ranged from 3.8 percent (Sensex) to 0.5 (Jakarta Composite). The Shanghai Composite and Hang Seng were down 2.4 percent and 1.9 percent respectively while the Taiex slid 3.5 percent. Besides events in Europe, economic data disappointed. In particular, Australian employment was down as were Japan’s private core machine orders. While China’s price data brought good inflation news, soft industrial output raised growth worries. Now investors will be looking for more monetary policy easing from the Peoples Bank of China.

Reserve Bank of New Zealand

As expected, the RBNZ left its key official cash rate (OCR) at 2.5 percent where it has been since March. The OCR was lowered at that time after the devastating Christchurch earthquake. In its statement, the RBNZ said that monetary policy would remain supportive for some time to come, citing the volatile EU and weakening Asian export market. In his statement Reserve Bank governor Alan Bollard said that global conditions had deteriorated. Continuing difficulties related to sovereign and bank debt in a growing number of European economies have resulted in high levels of volatility in financial markets. There has also been a softening in international economic activity, including in the Asia-Pacific region. He noted that thus far, global developments were having some negative impact on New Zealand, though to date it has been limited. Business confidence has declined and investment spending is likely to remain weak for some time. In addition, tightness in international markets means funding costs for New Zealand banks will increase to some degree over the coming year.

Reserve Bank of Australia

As expected, the Reserve Bank of Australia cut its key interest rate by 25 basis points to 4.25 percent. This follows last month’s interest rate cut of 25 basis points. Third quarter consumer prices showed annual underlying inflation averaging about 2.5 percent, which is the mid-point of the RBA's 2 percent to 3 percent inflation target range. But employment has weakened this year as the Australian dollar's climb to a record has hurt manufacturing and tourism. Consumers, instead of spending, have salted away cash. The economy added only 44,700 jobs in the 11 months so far in 2011 while it added 366,600 for the same period in 2010.

In his statement, RBA governor Glenn Stevens said that the inflation outlook had allowed the cut in interest rates. The outlook for inflation is likely to be in the 2 percent to 3 percent range. He also noted that “financing conditions have become much more difficult, especially in Europe.” “This, together with precautionary behavior by firms and households, means that the likelihood of a further material slowing in global growth has increased,” Growth in China — Australia’s biggest trading partner — has also slowed.

The cut marked the RBA’s first consecutive easing since the depths of the world financial crisis in 2009 and reflected a worsening global outlook that is weighing on exports. The local housing industry has slumped, with mortgage loan growth falling to a record low. The RBA traditionally does not meet in January. Its next meeting is scheduled for February 2012.

Currencies

Investor angst was played out in the foreign exchange markets once again last week. The euro was buffeted by every rumor concerning the EU summit and the ECB meeting. For example, euro fell the most in three weeks against the yen and slumped against the dollar after European Central Bank President Mario Draghi did not signal a stepping up in bond purchases. And on Friday, the euro dropped below the $1.33 level before rebounding on the summit announcement. The yen was up on increased demand for safety as European leaders gathered in Brussels for a two-day meeting to address the debt crisis.

Standard & Poor’s move to place the European Union’s AAA long-term rating on “creditwatch negative” after a similar action a day earlier on 15 of the 17 euro members also depressed the euro. The rating agency said it may lower the ratings of Germany and other members of the euro due to “continuing disagreements” about how to tackle the sovereign debt crisis.

Selected currencies — weekly results

Indicator scoreboard

EMU

October retail sales were up 0.4 percent but were 0.4 percent lower on the year. Volumes were unchanged from their third quarter average when they also showed no growth when compared with the previous period. In October sales of food, drink & tobacco were up 0.2 percent on the month while, excluding fuel, non-food demand was a relatively healthy 0.5 percent stronger. As usual performances across the region were decidedly mixed and a 3.3 percent monthly slump in Portugal contrasted sharply with a 3.7 percent surge in Malta. Among the larger four states, purchases rose 0.8 percent in France and 0.7 percent in Germany but fell 0.7 percent in Spain.

Third quarter gross domestic product was unrevised in the second estimate leaving total output 0.2 percent stronger than in the previous period and 1.4 percent above its year ago level. The modest advance followed another 0.2 percent quarterly increase in the second quarter when annual growth was 1.7 percent. The first look at the GDP expenditure components revealed a 0.3 percent quarterly gain in household consumption that only partially offset the 0.5 percent decline in the previous period and a minimal 0.1 percent rise in fixed capital formation. Government spending, for the third time in the last four quarters, was flat while inventories subtracted 0.2 percentage points from the bottom line having added 0.1 percentage points in each of the previous three quarters. The main impetus to growth came from the foreign trade sector. A 1.5 percent jump in export volumes easily eclipsed a 1.1 percent gain in imports so that net exports added 0.2 percentage points to quarterly growth, half the contribution made in the second quarter.

Germany

October manufacturing orders were up 5.4 percent after sinking a steeper revised 4.6 percent the month before. On the year, orders were up 5.4 percent. October's jump was led by capital goods which recovered from a 4.7 percent monthly drop in September with a leap of 7.8 percent. However, both basics (2.0 percent) and consumer & durable goods (1.3 percent) also posted respectable gains. Domestic orders were up a relatively modest 1.4 percent on the month (basics 2.0 percent) but it was overseas markets that provided the real impetus. Total foreign orders climbed 8.3 percent, shared between an 8.9 percent rise in Eurozone demand and a 7.9 percent advance elsewhere. Within the EMU area, capital goods orders were 16.2 percent stronger but this needs to be seen in the light of a 16.1 percent plunge last time. The huge volatility of the orders data continues to make monthly comparisons all but meaningless. September was almost certainly not as weak as indicated but by the same token, October was not as robust. More usefully, the two-month moving average shows an overall decline of 2.7 percent (domestic 3.9 percent, foreign 1.8 percent) and this probably gives a reasonably accurate view of the underlying trend.

October industrial production was up 0.8 percent after sinking a revised 2.8 percent in September. On the year, output was up 4.1 percent. The monthly gain was dominated by a 2.2 percent bounce in capital goods, although even this only reversed around half of the 4.5 percent drop that it suffered in September. Consumer durables (2.5 percent) also enjoyed a good month but overall consumer goods production was only flat as nondurables were down 0.5 percent. Intermediates dropped 0.4 percent after a 2.7 percent decline last time while energy advanced 1.1 percent and construction 0.4 percent. Overall manufacturing climbed 0.8 percent on the month.

October seasonally adjusted merchandise trade surplus narrowed from a slightly smaller revised €15.1 billion in September to €12.6 billion. The unadjusted data showed the black ink falling almost €6 billion to €11.6 billion. The October deterioration reflected a 3.6 percent monthly drop in nominal exports that more than offset a 1.0 percent decline in imports. The former fell to their second weakest level since April while the dip in the latter was the third in as many months. Compared with a year ago, growth of exports dropped to just 3.8 percent within which, significantly, purchases from the other EMU states were down 0.4 percent. Imports were 8.6 percent higher than in October 2010.

France

October merchandise trade deficit narrowed to €6.3 billion from a revised €6.6 billion in September. The minor improvement reflected a 0.5 percent increase in exports, largely due to higher sales from the transport and agri-food sectors, as well as a 0.3 percent dip in imports on the back of weakness in aviation and chemicals. Exports were still 5 percent short of the high they reached in August and the October shortfall itself was more than 6 percent above its third quarter average. At €61.5 billion the cumulative red ink over the first 10 months of the year was 47 percent larger than during the same period of 2010.

October industrial production excluding construction was flat on the month after a significantly steeper revised 2.1 percent slump in September. Annual growth was boosted by positive base effects, rising to 1.8 percent from just 0.9 percent last time. The October slide, which left output 1.3 percent below its third quarter average, reflected monthly gains in refining (2.7 percent), transport equipment (1.9 percent) and electronics & machinery (0.5 percent) that were offset by droops in food & agriculture (0.4 percent), the other manufacturing goods sector (0.6 percent) and energy (0.2 percent). Construction was also off 0.5 percent.

Italy

October industrial production dropped 0.9 percent and was down 4.2 percent on the year. The weakness was broad based but led by a 5.3 percent monthly drop in both the consumer goods and energy sectors, the former having already collapsed 7.1 percent in September. Output of intermediates sank 3.8 percent while capital goods production was off 3.0 percent. Overall manufacturing was down 0.6 percent. Total industrial output has now fallen in five of the last six months.

United Kingdom

October industrial production was down 0.7 percent on the month and 1.7 percent on the year. Manufacturing output also dropped 0.7 percent but edged up 0.3 percent from a year ago. The monthly decline in manufacturing output reflected declining activity in eight industries and higher production in just five. The main areas of weakness were basic metals & metal products (down 2.1 percent), other manufacture & repair (down 2.9 percent) and pharmaceuticals (down 2.7 percent). By contrast, machinery & equipment expanded 2.5 percent. Elsewhere, the effects on total industrial production of a 4.9 percent monthly slide in energy supply was in part offset by a 2.7 percent gain in oil & gas extraction and, to a much lesser extent, a 0.2 percent increase in water & waste management.

October merchandise trade deficit narrowed to Stg7.6 billion from a larger revised record high of some Stg10.2 billion in September. The improvement was mainly attributable to a record 8.7 percent monthly surge in exports although a 1.5 percent drop in imports helped too. Excluding oil and erratics, export volumes were up an even larger 9.0 percent from October while real imports matched their overall nominal decline. Within total exports, there were especially good performances by chemicals and capital goods. Sales of silver were also strong. The deficit with the rest of the EU narrowed from Stg4.5 billion in September to Stg3.0 billion and with non-EU bloc from Stg5.7 billion to Stg4.6 billion.

November output prices were up 0.2 percent and up 5.4 percent on the year. Input prices edged up 0.1 percent on the month and were up 13.1 percent on the year. Within overall output prices, the majority of sub-sectors saw relatively minor changes on the month. The most significant was petroleum products (0.6 percent) followed by alcohol and tobacco (0.4 percent). The steepest monthly decline was in paper & printing (0.3 percent). The core index was only unchanged on the month and 3.2 percent higher on the year, down from the annual October rate and 0.5 percentage points shy of the 3.7 percent high registered in September. Excluding duty, annual factory gate inflation was running at 5.6 percent or 0.3 percentage points below the previous period's rate. Input costs were lifted by a 2.6 percent monthly jump in fuel prices and a 0.7 percent bounce in crude oil. However, all the other categories saw declines, led by imported parts & equipment (0.5 percent) and other imported materials (0.6 percent).

Asia/Pacific

Japan

October private machine orders dropped 6.9 percent after sinking 8.2 percent in September. On the year orders were up 1.5 percent. Private sector machinery orders exclude volatile ones for ships and those from electric power companies. But even excluding those volatile items, orders continue to fluctuate from month to month. Manufacturing orders were up 5.5 percent after plunging 17.5 percent the month before. Nonmanufacturing orders were down 7.3 percent after rising 8.5 percent in September. Orders from overseas were up 1.6 percent after sinking 21.7 percent the month before.

Third quarter gross domestic product was revised down to an increase of 1.4 percent from the previous estimate to 1.5 percent on the quarter. When compared with the same quarter a year ago, GDP was down a revised 0.8 percent. The annualized rate was revised down to 5.6 percent from 6.0 percent. Among the major components, private non-residential investment was revised from its original estimate of an increase of 1.1 percent to a decline of 0.4 percent on the quarter. Domestic demand was also revised downward from the first estimate of 1.0 percent to 0.8 percent. Private consumption was revised down from 1.0 percent to 0.8 percent.

Australia

September quarter gross domestic product was up 1.0 percent as expected on the quarter after a revised increase of 1.4 percent in the June quarter. On the year, GDP was up 2.5 percent after growth 1.9 percent the quarter before. Consumption expenditures were up 0.6 percent and 3.1 percent on the year. Gross fixed capital formation was up a healthy 6.0 percent on the quarter and 8.7 percent on the year. The growth for the quarter was driven by a 1.5 percent contribution to growth from capital expenditure on non-dwelling construction, a 0.4 percent contribution from final consumption expenditure and a 0.4 percent contribution from capital expenditure on machinery & equipment. The increases were partially offset by change in inventories which subtracted 0.8 percentage points and a 0.6 percent subtraction from net exports. The industries that drove growth in the September quarter were construction with a 0.4 percent contribution to growth and mining with a 0.3 percent contribution.

November employment was down by 6,300 to 11,457,100. October employment was upwardly revised to 16,800. The November decrease was driven by a decline in full time employment, which was down 39,900 people to 8,026,300. It was partially offset by an increase in part time employment which was up 33,600 people to 3,430,800. The unemployment rate increased 0.1 percentage point to 5.3 percent. The number of people unemployed increased by 9,400 people to 635,800. Monthly aggregate hours worked was down 11.3 million hours to 1,616.8 million hours. The labor force participation rate edged down 0.1 percentage point to 65.5 percent. At its meeting on Tuesday, the RBA reduced its key interest rate for a second month to 4.25 percent as slowing economic growth in China and the turbulence in Europe have cut into export growth.

China

Consumer price pressures continued to ease in November giving the Peoples Bank of China more latitude to ease monetary policy. The CPI was down 0.2 percent on the month and up 4.2 percent on the year. Analysts were expecting an annual increase of 4.4 percent. For the 11 months through November, the CPI was up 5.5 percent after increasing 5.6 percent last time. The urban CPI was up 4.2 percent while the rural CPI was up 4.3 percent on the year. Food pressures eased to an increase of 8.8 percent from 11.9 percent in October and 13.4 percent in September. Housing costs eased to 3.0 percent from 4.4 percent the month before.

Producer prices eased in November along with consumer prices. The PPI was down 0.7 percent on the month for the second consecutive month. On the year, prices were up 2.7 percent after climbing 5.0 percent in October. For the year to date, the PPI was up 6.4 percent after increasing 6.8 percent last time. On the year, production materials prices were up 2.6 percent after jumping 5.2 percent in October. Consumer goods were up 3.1 percent after increasing 4.2 percent last time. Fuel & power price increases eased to 9.3 percent from 11.3 percent.

November retail sales were up 1.3 percent on the month to nudge annual sales growth from 17.2 percent in October to 17.3 percent. Over the first eleven months of 2011, purchases were up 17.0 percent on the year, unchanged from the rate over the January to October period. The largest improvement was in home appliances where annual demand growth jumped nearly 10 percentage points to 25.0 percent but there were also strong gains in communications equipment (31.3 percent after 24.5 percent) and in sports & recreation (15.1 percent from 9.8 percent). Other categories typically posted smaller increases but the 12-month rise in autos purchases slowed to 11.4 percent from 12.6 percent.

November industrial production was up 0.91 percent on the month but, at 12.4 percent after 13.2 percent in October, annual output growth slowed rather more quickly than generally expected. Over the first eleven months of the year, production was 14.0 percent firmer. The main areas of slowdown were steel products, where annual output growth dropped to 7.8 percent from 13.4 percent and cement (11.2 percent from 16.5 percent). A number of other categories saw a more modest deceleration but production rates picked up in chemicals (14.5 percent from 13.1 percent) and machinery (11.6 percent from 10.8 percent).

Americas

Canada

October merchandise trade balance plunged into a deficit of C$884.5 million from a revised surplus of C$1.03 billion. Exports sank 3.0 percent while imports surged 1.9 percent. The slide in exports was broad based with just autos (4.0 percent) among the major commodity groupings showing any growth on the month. Industrial goods & materials (down 6.0 percent) showed their first decline in half a year and there were sizeable drops in energy (5.9 percent), forestry (4.3 percent) and the other consumer goods category (3.7 percent). Imports were supported by a 3.8 percent monthly bounce in machinery & equipment which was compounded by a 3.0 percent gain in energy. Autos (1.8 percent) also fared well but there were modest declines in agriculture (0.2 percent), forestry (0.9 percent) and other consumer goods (0.1 percent). Regionally the bilateral surplus with the U.S. narrowed to C$3.1 billion from C$4.1 billion. The trade deficit with countries other than the United States increased from C$3.0 billion toC$4.0 billion.

Bottom line

Investors focused on Europe once again last week, and will probably continue to do so as the new agreement is finalized. Economic data from Japan, Australia, China, Europe and the UK indicated deteriorating growth. US data, what there was, was mostly positive with jobless claims declining and consumer sentiment improving. Two of five central banks meeting last week lowered their key interest rates by 25 basis points — the Reserve Bank of Australia to 4.25 percent and the European Central Bank to 1.0 percent. The Banks of England and Canada and the Reserve Bank of New Zealand left there interest rates at 0.5 percent, 1.0 percent and 2.5 percent respectively.

While U.S. data dominates the economic calendar next week, in Japan, the quarterly Tankan Survey will be released. In the UK, the labour market report and retail sales are on tap. In Europe, the flash December PMI indexes will be posted. The Federal Reserve holds its policy meeting. And of course, the European debt situation will continue to be front and center as investors try to figure out what it all may mean for them.

Looking Ahead: December 12 through December 16, 2011

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