Global Markets

It was a week of waiting as investors focused on events that would not occur until Thursday and Friday. They awaited the policy announcements from the Bank of England and the European Central Bank — they expected easing from both. And of course, everyone was waiting for the U.S. employment report on Friday. Even though the People’s Bank of China surprised and reduced interest rates for a second consecutive month, investors were disappointed by the limited action taken especially by the ECB. And on Friday, the employment report was weaker than anticipated.

Although their actions were not synchronized to occur together, the Bank of England, the People’s Bank of China and the European Central Bank announced policy changes within 45 minutes on Thursday morning (US ET). While they eased monetary policy, they took different approaches. The PBoC and ECB cut their policy interest rates while the BoE expanded its asset purchase program. The BoE and ECB announcements occurred after their regularly scheduled monthly meetings while the PBoC announcement was a surprise.  

The PBoC said it would lower the Bank’s one year lending rate by 31 basis points to 6.0 percent and its one year deposit rate by 25 basis points to 3.0 percent. After leaving rates untouched for three years, the PBoC has now lowered borrowing costs twice since June 7^th. The PBoC also allowed banks to offer bigger discounts on their own lending costs. Banks can offer loans of as much as 30 percent less than benchmark rates. Officials responded after two manufacturing indexes fell in June and ahead of a slew of monthly economic data along with a report on second quarter gross domestic product.

The Bank of England left its key interest rate at 0.5 percent and raised the target of its asset purchase program by £50 billion to £375 billion. According to the Monetary Policy Committee, “UK output has barely grown for a year and a half and is estimated to have fallen in both of the past two quarters.” It also said that the pace of expansion in most of the United Kingdom’s main export markets appears to have slowed.

As widely expected, the ECB Governing Council announced a 25 basis cut in the refinance rate to 0.75 percent. This was the third reduction in the ECB’s benchmark rate since Mario Draghi took over as ECB President last November and was accompanied by equivalent cuts in both the deposit and marginal lending rates to zero and 1.50 percent respectively. By lowering the deposit rate that it pays to banks holding funds in its overnight facility to zero, the ECB is hoping to make lending to the private sector a more attractive option. With the ECB’s president having already expressed his contentment with the outcome of last week's EU leaders' summit, the door was always ajar to the adoption of an easier monetary stance. As it is, the new cut leaves the refi rate at a record low, a level that the ECB would have considered all but impossible a year ago when it was in the midst of a new tightening cycle.

The move comes against the backdrop of the on-going crisis in Eurozone financial markets and amidst increasing evidence that the region's economy is not living up to official expectations. Inflation, provisionally at 2.4 percent in June, is still above target but also well beneath the recent September 2011 high (3.0 percent) and at a 16-month low. At the same time, M3 money supply growth remains insipid at best. However, it remains to be seen how much impetus to economic growth a 25 basis point cut can provide when real borrowing costs are already strongly negative.

At his press conference, Draghi pointed to heightened economic uncertainty weighing on consumer and business sentiment. Eurozone growth is expected to recover gradually but with increased downside risks and constrained by banks' on-going efforts to recapitalize their balance sheets. However, as generally anticipated, there was no announcement of any new unconventional policy measures and the ECB chief was at pains once again to emphasize the temporary nature of those already in place.

Markets were disappointed that the ECB did not do more to help the pain in both Spain and Italy. The ECB continues to put the onus on Eurozone governments to solve the debt crisis and did not even discuss non-standard measures such as buying Spanish and Italian bonds to lower borrowing costs.

On Tuesday (local time), the Reserve Bank of Australia kept its cash rate at 3.5 percent after lowering it by a total of 75 basis points at its last two previous meetings. The RBA lowered the cash rate by 50 basis points in May and 25 basis points in June. Most likely, the RBA will await further inflation information before acting again. Second quarter CPI data will be released prior to its August meeting. Even after last month’s rate cut, Australia has the highest borrowing costs among major developed nations. From the point of view of the domestic economy, the RBA is unlikely to see any big reason to make monetary policy more stimulative. However, the global outlook continues to dominate a lot of the RBA’s discussion.

Manufacturing weakens globally

Central bankers along with investors monitor the Markit manufacturing PMI indexes for early indications of factory output health. What watchers saw this week was a global weakening in the manufacturing output sector. Of the countries tracked here, only the U.S. and India index readings were  above the breakeven level of 50 growth/no growth level. The remaining countries are contracting. However, although still contracting, the readings for both Australia and the UK improved markedly in June while France showed some progress.

Global Stock Market Recap

Europe and the UK

Most equity indexes were down on the week, pressured by disappointment in the ECB’s limited policy move and Friday’s weak U.S. employment report. Losses were most pronounced in Italy and Spain because of the pressures on government finances and banks there. Equities in the two countries were hit hard as the ECB move was deemed to be insufficient to help either country. Bond yields in Spain rose to unsustainable levels. Investors were disappointed that the ECB did not hint that it would pump more money into the banking system. The four indexes domiciled in Eurozone member states — the CAC, DAX, MIB and IBEX — dropped 0.9 percent, 0.1 percent, 3.8 percent and 5.1 percent respectively. The FTSE was 1.6 percent higher while the SMI gained 1.9 percent and the OMX was up 0.5 percent.

Many analysts said that the ECB’s monetary policy easing — although unanimous and significant — amounts to little more than a 'tweaking at the edges' as far as the ailing peripheral economies are concerned. Some commentators said that the ECB’s action was potentially a sign that the global recession was deepening. In his news conference, ECB President Mario Draghi warned that risks to the economic outlook remain tilted to the downside. He brushed off questions about whether the Bank would engage in another round of cheap, unusually lengthy lending, known as an LTRO, or Long Term Refinancing Operation. And there was no indication that the ECB would restart the moribund Securities Markets Program, a program of government debt purchases.

Asia Pacific

Although most indexes were up for the week — the Shanghai Composite the exception — trading ended Friday on a sour note. Most markets here were down on Friday as worries resurfaced over the global economy. However, mainland Chinese stocks climbed following Thursday’s surprise interest rate cut by the People’s Bank of China for the second time in less than a month, a response to the country's worst slowdown since the global financial crisis. Traders were cautious Friday as they awaited the U.S. employment report, which would be released after markets here are closed for the week.

Currencies

The U.S. dollar was up against all of its major counterparts with the exception of the yen as investors sought safe havens after U.S. employers added fewer jobs than expected in June. The dollar strengthened to a two year high against the euro. The yen gained against the U.S. dollar as the last employment report before the Federal Reserve’s next meeting showed the jobless rate stayed unchanged at 8.2 percent. Downward pressure on the euro also came from a slide in Spanish industrial production along with other economic indicators during the week that added to concern Europe’s debt crisis will worsen. The question that traders will undoubtedly debate until the next FOMC meeting on July 31^st and August 1^st is whether the employment report is weak enough to warrant additional easing (QE3). The U.S. dollar has gained over 5 percent against the euro this year as investors seek safety amid speculation Europe’s financial turmoil is worsening and U.S. growth is slowing.

Selected currencies — weekly results

Indicator scoreboard

EMU

May unemployment rate edged to a record 11.1 percent from 11.0 in April. The number of people out of work was up 88,000 on the month at 17.561 million, an increase of 1.820 million from May 2011. However, the monthly increase was still well short of the 116,000 advance reported at the start of the quarter. Regionally, the national unemployment rate was up 0.1 percentage points to 10.1 percent in France and another 0.3 percentage points to 24.6 percent in Spain. However, the German rate was unchanged and, somewhat surprisingly, the rate in Italy slipped 0.1 percentage point to 10.1 percent. Portugal registered no change (15.2 percent) in line with Ireland (14.6 percent).

May producer prices (excluding construction) posted their first monthly decline of the year in May. The PPI dropped 0.5 percent and reduced annual PPI inflation from 2.6 percent in April to 2.3 percent, its slowest rate since March 2010. The headline decline was dictated by the energy sector where prices slumped 1.4 percent from the start of the quarter and were up 6.4 percent on the year after a 6.7 percent annual gain last time. Nonetheless, weakness was broad based and even excluding this category the PPI was only steady at its April level, enough to reduce the 12-month underlying rate by 0.2 percentage points to 1.1 percent. Charges were unchanged on the month for intermediates, capital and durable consumer goods and edged 0.1 percent lower for nondurable consumer goods. Regionally there were monthly declines in most member PPIs with especially sharp drops in Greece (1.4 percent), France (1.1 percent) and Finland (0.8 percent). However, a minority of countries saw increases, notably Cyprus (2.1 percent) where annual PPI inflation now stands at 9.1 percent, well out of line with the rest of the bloc.

May retail sales were up 0.6 percent on the month. However, the mid-quarter advance followed a steeper revised 1.4 percent decline in April and left annual sales down 1.7 percent. Average purchases in April and May were 1.0 percent below their first quarter mean when they edged just 0.2 percent higher and will be seen as increasing the likelihood of a contraction in second quarter real GDP. In May excluding fuel, sales of food, drink & tobacco were up just 0.2 percent on the month while a respectable 1.0 percent increase in the non-food sector only followed a sharper revised 1.7 percent slump in April. Regionally retail demand was higher on the month in most EMU members although Germany bucked the trend with a second successive decline (0.3 percent). Sales in both France and Spain climbed 1.2 percent but both failed to recover their respective losses posted in April. The strongest gain was seen in Portugal (2.9 percent) but purchases here were still some 5.1 percent weaker on the year.

June services PMI reading was 47.1, up 0.3 points from its initial reading and 0.4 points above the final May outcome but still indicative of a fifth consecutive contraction. New business lost ground for the 10th month in a row, albeit not quite as quickly as in May, while backlogs were off for their 12th consecutive month. Employment similarly declined, extending the trend that began at the start of the year. However, probably most significant was a near record drop in year-ahead business expectations. Input cost inflation essentially matched the 22-month low seen in May while charges fell at their fastest rate since February 2010. For the larger EMU states, the German PMI fell a larger revised 1.9 points to 49.9, ending eight successive months of growth, but the French index was revised 0.6 points firmer to 47.9, up nearly 3 points from May and a 3-month high. Italy (43.1) rose 0.3 points on the month but, in line with Spain (43.4), remained low enough to make little real difference. The composite output index that provides a proxy for real GDP was revised up 0.4 points to 46.4 after a 46.0 reading in May. Despite the amendment, the second quarter average was still the lowest in three years and points to what should be another contraction in total Eurozone output.

Germany

May manufacturing orders were up 0.6 percent after sinking a revised 1.4 percent in April. Orders were 5.4 percent lower than a year ago. The latest headline figures were boosted by a 3.5 percent monthly bounce in consumer & durable goods orders, although this failed to fully reverse April's 4.5 percent slump. Basics were up 0.8 percent while capital goods were 0.2 percent higher. The domestic market was weak, posting a 1.3 percent monthly decline led by capital goods (2.0 percent) and consumer & durables (2.2 percent). By contrast overseas orders were up 2.3 percent from April with consumer & durables jumping 8.6 percent after a 7.6 percent plunge in April. Shipments to the other Eurozone members surged 7.7 percent (capital goods 11.0 percent) and so comfortably more than offset a 1.3 percent contraction in the previous period. Non-Eurozone countries registered a 0.8 percent monthly drop.

May industrial production was up 1.6 percent and unchanged from a year ago. Within the advance in overall production, manufacturing expanded 1.8 percent on the month after a 2.3 percent drop last time. The mid-quarter gain was largely thanks to a 3.8 percent bounce in consumer goods, itself based upon a 4.0 percent rebound in nondurables. However, there were improvements elsewhere too with intermediates up 1.0 percent on the month and capital goods 1.7 percent. By contrast, energy output dropped 1.6 percent and so partially reversed April's 2.4 percent increase while construction expanded 3.1 percent following a 5.5 percent drop last time.

United Kingdom

June producer input prices dropped 2.2 percent on the month and declined 2.3 percent on the year. Output prices slid 0.4 percent and were up 2.3 percent on the year, its lowest level since October 2009. A 3.3 percent drop in petroleum costs did much to explain the weakness of headline output prices but with the core index 0.2 percent lower on the month, there were further signs of an improvement in the underlying picture too. The chemical & pharmaceuticals sector together with textile & leather products saw significant declines in charges. The annual core rate dropped 0.3 percentage points from a firmer revised May base to 2.0 percent. Input costs were similarly held in check partly by weaker fuel prices which were off 0.8 percent on the month. However, most areas posted fresh declines and the core index was 0.9 percent lower than in May, its third consecutive monthly decline.

Asia/Pacific

Japan

Second quarter Tankan survey of large manufacturers showed that sentiment improved more than expected. The large manufacturers index reading improved to minus 1 – up from minus 4 in the first quarter and above the consensus forecast of minus 3. It is the highest level since plus 2 in September 2011. The index is calculated by subtracting the percentage of firms saying business conditions are bad from those saying they are good. The Tankan is taken into account by the BoJ when formulating monetary policy. Sentiment among large nonmanufacturers improved to plus 8 in June compared with plus 5 in March. Big manufacturers and nonmanufacturers plan to increase capital spending by 6.2 percent in the current fiscal year that started in April. In March, they forecast that their capital expenditure would remain unchanged. Meanwhile, small manufacturers’ index reading was minus 12, down from March’s minus 10. However nonmanufacturing improved to a reading of minus 9 from minus 11 the quarter before.

Australia

May retail sales were up a stronger than expected 0.5 percent on the month after increasing only 0.1 percent in April. Analysts expected sales to edge up 0.2 percent. On the year, retail sales were up 3.5 percent. Most sectors were up on the month. Cafes, restaurants & takeaway food services (1.4 percent) and household goods retailing (0.8 percent) were the main drivers of the growth. Other retailing (0.7 percent), department stores and clothing, footwear & personal accessory retailing (0.5 percent) also was higher. Food retailing (down 0.1 percent) was the only industry to slip in May. Over the longer term food retailing is still the main contributor to growth (up 0.4 percent in trend terms) along with cafes, restaurants & takeaway food services (up 1.0 percent in trend terms).

May deficit on goods and services was A$285 million after recording a revised A$26 million deficit in April. This was the fifth consecutive monthly trade deficit this year. Exports were up 2.2 percent on the month and 0.9 percent on the year. Non-rural goods exports were up 2 percent while non-monetary good was up 15 percent. Rural goods edged up 1 percent. Services exports were up A$4 million. Imports were up 3.2 percent and 14.6 percent on the year. Intermediate and other merchandise goods were 6 percent higher while capital goods was up 3 percent, non–monetary gold jumped 27 percent and consumption goods increased by A$10 million. Services imports were up 1 percent.

Americas

Canada

June employment was up 7,300 while the unemployment rate edged down to 7.2 percent from 7.3 percent in May. However, jobs growth was concentrated in the public sector which added nearly 39,000 positions while the private sector posted a 26,000 decline. Self-employment was also down 5,500. The gain was attributable to strength in full time employment which was up 29,300. By contrast, part time jobs dropped 22,000. The goods producing sector dropped 21,200 with much of the decline occurring in agriculture (19,700) while manufacturing was down just 800. Construction saw a 3,000 drop and natural resources were off 5,100 but utilities advanced 7,400. Services added a net 28,400 new positions. Within this, business, building & other support services (24,200), health care & social assistance (19,900) and education (19,300) all fared well and there was a solid increase also in finance, insurance, real estate & leasing (13,900). Retail expanded 5,300. However, other areas struggled and there were sizeable declines in information, culture & recreation (31,000) and accommodation & food (13,500) while transport and warehousing shed almost 7,000.

Bottom line

Equities were mixed as investors waited for — and then reacted to — the various central bank announcements. The data released during the week confirmed that global growth is weakening.

Investors find out this week if the data from China for June along with its second quarter growth data warranted a second consecutive monthly decline in interest rates from the PBoC. The Bank of Japan meets and will be monitored closely to see if it also eases its policy even more.

Looking Ahead: July 9 through July13, 2012

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