Europe
The euroland economies are continuing to show signs of renewed growth last week. Official numbers are supporting anecdotal comments. Business confidence is rebounding in Germany, France and Italy. Consumers are spending more. Manufacturing orders are up. The European Central Bank also helped by dropping interest rates by 0.5 percent to 2.5 percent in April. Even the euro has bounced back from its lifetime low of $1.014. Indeed, part of the reason for Europe's recovery is the euro's decline during the first six months of the year, which made euroland's exports more competitive. The region conducts about 40 percent of their trade with Great Britain and the United States. Britain's economy is recovering while the United States economy remains strong.

The focus now is how to turn the recovery into sustained growth. There are three reasons for optimism.

• Euroland governments are beginning to commit themselves to deregulation. They are also beginning to look for ways to fix the structural problems that have plagued them.
• Businesses are beginning to reorganize and merge. Cheaper borrowing in the eurowide bond market has been advantageous.
• Demographics are beginning to help with chronic labor force problems. The workforce is shrinking in size because it is aging and retiring employees outnumber their replacements. Italy, France and Germany have levels of unemployment that are roughly double those of the United States.

The data provide the proof
Germany supplied both good and bad news last week. June industrial production, unchanged in June, disappointed the markets. There was a marked divergence between manufacturing orders, which rose 1.7 percent in June, and stronger than expected trade data when compared with flat industrial production. The trade data reflected a strong rise in exports (up 4.6% on the year) and weak imports (up only 0.6%).

Even though industrial production was unchanged in June, output is expected to pick up strongly based on the jump in manufacturing orders and the business optimism as expressed in recent sentiment surveys. The difference indicates that there is a greater lag between orders and production than analysts expected.

An indication that consumers are beginning to participate in the upturn came in the form of German retail sales. They rose 2.4 percent seasonally adjusted and 3.5 percent on the year, underlying recent signs of a pickup in the German economy.

The United Kingdom's unemployment rate, at 4.3 percent, is the lowest since March 1980. The drop highlights Britain's two track economy with sharp growth in the service sector and continued hardship for manufacturers. Like the United States, manufacturers are feeling the affects of a strong currency, which cuts into export sales. Service employment continued to rise while manufacturing employment continued to drop. Retail sales in the United Kingdom also grew faster than analysts had expected.

The Bank of England issued its quarterly inflation report last week. Market players study the report in order to gauge future monetary policy. Most importantly for the market, the report contains the Bank's expectations for growth and inflationary trends. Since the Bank's Monetary Policy Committee is bound to an inflation target of 2.5 percent in its monetary policy making role, no stone is left unturned to understand the inputs to the decision making process by committee members.

In the inflation report, the Bank said that the immediate outlook is for growth with low inflation, but that the balance of inflationary risks had moved slightly to the upside. The Bank also acknowledged that Britain's recovery seemed more firmly entrenched, but there were still some downside risks, mostly from weaker world output. Like the United States, weak world prices and a strong currency helped to subdue inflation over the past two years.

Asia
Japan released its revised estimate of first quarter gross domestic product on Friday. The number - which surprised forecasters - was revised up to 2 percent from 1.9 percent for the quarter and to 7.9 percent on an annualized basis. June machinery orders received by Japanese manufacturers, which rose 6.3 percent for the month bolstered the GDP report. The orders series is viewed as a leading indicator of corporate capital investment six to nine month ahead.

Japanese bankruptcies fell for the ninth straight month in July as government backed loan guarantees helped small companies avert failure. Corporate failures have steadily fallen since the government introduced a system of loan guarantees in October to curb bankruptcies at small companies, which were suffering as banks cut lending.

Underlining the continuing improvement in business sentiment, an Economic Planning Agency (EPA) survey indicated that Japanese companies were "less gloomy" in the second quarter than they were in the first quarter.

To sum up, the indicators last week were by and large encouraging and pointed to the continuing economic recovery of key world economies. Since many of the needed structural reforms are not yet in place, investors will have to continue to use caution when considering alternative investments outside the United States.

World Stock Exchanges
The key word to use when describing financial markets behavior is "volatile". Although many of the major markets closed up on the week, they fluctuated jerkily during the day and between days. Markets worldwide are obsessed with the U.S. inflation story and the possible interest rate increase on August 24th when the Federal Reserve Open Market Committee meets. It seemed as though the reaction to U.S. data appeared to have more of an impact on foreign markets than their own national indicators no matter how positive they were.

Higher interest rates are a double edged sword. They make dollar deposits more attractive by paying a higher interest rate. However, they could hurt bonds and stocks and reduce demand for the U.S. currency. Inflation erodes bond values while the higher rates needed to contain inflation add to borrowing costs and pull down earnings and stocks. Investors selling U.S. securities often convert the dollar proceeds into other currencies. That could hurt the dollar, and a falling dollar in turn, could discourage global investors from putting the money in U.S. assets because of eroding value.

Below is an illustration of just how jumpy the British FTSE and German DAX indexes have been and how their movements parallel each other.

How the Nikkei and yen interact
Each time the yen strengthens, exports become less competitive. That makes it harder for Japan to export its way out of its recession and saps demand from global investors for Japanese stocks and the yen needed to buy them. When the yen increases in value - that is, fewer yen per U.S. dollar - the benchmark stock index falls on concern that a stronger yen will erode profits from export sales that are converted into yen.

Foreign investors have been largely responsible for the 29 percent gain in the Nikkei average since the beginning of 1999. Few analysts believe that the rally is sustainable unless local investors begin to participate. U.S. investors think that if individual investors come back into the market, it will bolster the Japanese market recovery and push the broad market higher.

Currencies
The dollar rose 0.9 percent against the yen and 1.7 percent against the euro as inflationary fears in the United States proved to be unwarranted. Market players were really surprised at the benign U.S. producers price report. The Federal Reserve's Beige Book on the state of the U.S. economy - issued two weeks prior to the Federal Open Market Committee meeting- was "market friendly". The dollar's surge after the data release is indicative of a market that had been overly optimistic about European and Japanese growth when compared with the United States.

Heightened political tensions in Asia also are working to the dollar's advantage. Tensions with North Korea over threats of a long range missile test combined with the mounting tensions between China and Taiwan could easily rattle the markets. The dollar would once again be looked upon as a safe haven for investors should tensions escalate.

Why U.S. investors care
The positive outlooks for Europe and parts of Asia are a plus for U.S. investors. Besides providing alternative investment opportunities, it reinforces U.S. growth by providing expanded markets for our exports. While the crisis atmosphere in Asia has abated, many of the recoveries are still very fragile.

With the August 24th FOMC meeting fast approaching, the Fed, in addition to U.S. economic concerns, needs to consider the impact of higher U.S. interest rates on countries just beginning to recover from recession or slow growth. By making investments more attractive in the United States, these countries fear that investment funds that would otherwise be invested in their economies will be attracted elsewhere because of higher rates.

Looking Ahead

The following indicators will be released this week.

Europe
August 16	Germany	Wholesale Price Index (July)
August 17	UK	Retail Price Index (July)
August 18	UK	Retail Sales (July)
	UK	Minutes of the Bank of England
		Monetary Policy Committee released
August 19	France	Trade Balance (June)
	Italy	Consumer Price Index (July)
Asia
August 16	Japan	Industrial Production (June)
	Japan	Shipments and Inventories (June)
August 18	Japan	Minutes of Bank of Japan Monetary Policy Meeting
North America
August 17	Mexico	GDP (Q2)
	Canada	Survey of Manufacturing (June)
August 18	Canada	Consumer Price Index (July)
	Mexico	Retail Sales (June)
August 19	Canada	Merchandise Trade (June)
	Mexico	Open Unemployment (July)
August 20	Canada	Retail Sales (June

Release dates are subject to change.
For U.S. data releases, see this week's Simply Economics.