Oil
World economies are always sensitive to the supply and price of commodities, especially oil. Prices for oil are rising for two reasons - demand is rising while OPEC producers are limiting supply. As world growth recovers, more oil is demanded for factories and businesses, and this bids up the price of energy. At the same time, Organization for Petroleum Exporting Countries (OPEC) has, for the first time in many years, been able to enforce production quotas on its members, and this has decreased the supply available. The net result has been higher prices.

The commodity markets' sensitivity was visible last Tuesday when oil prices zoomed after two oil producing country ministers indicated that they were not in favor of increasing production to meet the growing demand around the world. After a decade and a half of lying, cheating and squabbling, members of the OPEC seem to have got their act together, although most people thought it would never happen.

As a result, oil prices have doubled during the past six months, much to the surprise of the biggest oil companies and their shareholders. This strength reflects a growing consensus in the oil industry - after a period of skepticism in mid-summer - that higher oil prices are here to stay. Already Saudi, Venezuelan and Mexican officials have agreed to maintain output cuts through the end of next March. The ministers' statements emphasized the crucial role that strict compliance is playing in oil's recovery along with the importance of ensuring that an expected decline in global inventories actually materializes.

Although OPEC appears set to adopt a status quo approach to quotas at their September 22nd meeting, recent surveys suggest that some producers began to edge up production last month. During the week, a chorus of influential members - including Iran, Mexico and Saudi Arabia - suggested that producers monitor and react to inventory levels instead of prices as proposed by Venezuela. The oil glut is shrinking and some analysts are forecasting a substantial inventory erosion beginning in October as the heating season approaches. However, a rapid reversal is always possible in a market that depends on the resolution of a few oil ministers to avoid temptation. As the price rises, the pressure to push up earnings by producing more oil becomes ever higher. However, the severe economic difficulties of many oil producing countries, such as Nigeria and Venezuela, appear to make discipline more likely. And although OPEC countries produce only about 40 per cent of the world's oil at present, they have nearly three-quarters of reserves.

A re-run of the seventies' grim story when supplies shrank, oil prices skyrocketed and inflation soared is unlikely. Inflationary pressures remain extremely subdued despite the recent rise in oil and other non-food commodity prices. A large part of the world economy is just emerging from the threat of a deflationary recession. The unexpectedly strong signs of recovery in southeast Asia and a better outlook for Europe have helped to raise the demand for oil. The buildup of excess stocks has been reversed; but this would be a benign result of continued steady growth - if it can be sustained - in most of the industrialized world.

The west has become far less dependent on oil. Six years of prices above $30 (in today's money) in the early 1980s led to big changes in consumption. This reflected not only deliberate policy, such as the encouragement of smaller car engines and improvements in industrial efficiency, but also the fact that energy intensive industries have become a declining part of advanced economies.

In the period after 1985, when OPEC collapsed and oil prices fluctuated between about $15 and $20, the big oil companies made spectacular efficiency gains. The cost of finding, developing and operating a new source of oil has fallen to only about $6 per barrel, less than half the figures in the mid-1980s.

A barrage of indicators

Asia
Japan - Retail sales fell 2.5 percent in July from the previous year. Sales by large retailers and wholesalers sagged also. July's decline extended the streak of declining sales to a record 28 months. Retail sales in July were hurt by stagnant demand from corporations as well as poor weather. Overall, the deterioration in retail sales slowed; but sales unlikely to pick up anytime soon.

The Bank of Japan terms of trade index for manufacturers fell 0.5 for July. The index had been flat since the beginning of the year. The main reason was rising oil prices, which outweighed the effect of the yen's appreciation. A combination of a strong yen and worsening terms of trade will undermine Japan's recovery. Japan's imports from Asia rose 2.3 percent during April-June when compared with a year ago. This is positive news for the region, and also reflects a demand recovery in Japan. The yen and the Japanese stock market soared on the market's positive sentiment about the economy.

South Korea - Industrial output soared 33.1 percent in July, shifting from a fall of 14 percent a year earlier, thanks to rising exports and a pickup in domestic consumption. The rise is the highest since August 1976, when output surged 35.1 percent.

Australia - The trade deficit narrowed more than expected in July, helped by a jump in exports as demand for Australian goods picked up in Asia and Europe. Analysts expect the contraction to continue in the coming months, helping to narrow the current account deficit, which hit about 6.2 percent of gross domestic product in the second quarter.

Europe
The eleven members of European Monetary Union posted a preliminary trade surplus with the rest of the world of Euro8.7 billion in June, up from Euro8.3 billion a year earlier.

Germany - Nominal wholesale sales for July fell 3.7 percent compared with a year earlier and sales were down 3.0 percent after adjustment for inflation. Nominal wholesale sales in July rose a seasonally and calendar-adjusted 1.2 percent on the month.

France - The ILO rate fell to 11.2 percent from 11.3 percent in June. Manufacturing output in June rose a seasonally and workday adjusted 0.9 percent on the month and 0.7 percent on the year. This was much stronger than most analysts had expected. The International Labor Organization (ILO) definition of unemployment excludes job seekers that did any work in the month.

Italy -Producer prices in June rose 0.6 percent on the month but fell 0.7 percent on the year. The increase was expected, given the rise in oil prices and the stronger dollar. June adjusted retail sales rose 2.3 percent on the year, the highest level since December. The July non-EU trade surplus narrowed in line with expectations, with imports rising and the fall in exports is slowing.

Several European Purchasing Managers Index (PMI) surveys were released with mixed results. The European Monetary Union eleven overall reading gained slightly in August, as did Germany and Italy. Sweden's PMI rose to 60.9 from a previous reading of 49.2. (Scandinavian PMI's have tended to be quite volatile on a month by month basis.) Both the UK and France experienced slight dips. However, a common theme among all the indices was the rise in the price component. This is largely because of the recent rise in oil prices. Nevertheless, while the readings in August have not produced significant improvements, most of the increases experienced in the previous two months should be enough to support an improvement in the industrial production trend going into the third quarter.

Americas
Canada - Second quarter real gross domestic product rose 0.8 percent or 3.3 percent on an annualized basis. Second quarter growth was largely due to strength in the domestic economy particularly as investment of machinery and equipment and housing. Second quarter seasonally adjusted current account deficit increased slightly to C$1.3 billion seasonally adjusted quarterly rate. The higher deficit was led by services, notably transportation and travel. In addition, current transfers showed a lower net surplus than the high level of the first quarter. The goods trade surplus was largely unchanged.

Equity Markets
World wide, stock markets continued to be volatile as traders were driven by interest rate concerns. This, combined with relatively thin volumes as the last week of summer wound down, left the markets over responding to any speech, rumor or number. The European markets soared during their afternoon trading session Friday on the news that the U.S. employment report was weaker than expected. Despite large gains, both the FTSE (London) and DAX (Frankfurt) share indexes closed down on the week while the CAC (Paris) index eked out a minimal gain.

Asian markets were closed by the time the U.S. employment situation report was released. As a result, the South Korean and Australian markets finished down on the week while Japan stayed about the same despite intra-week volatility.

Currencies
A factor that ultimately affects the value of a currency is interest rate differentials. Currently, the administered interest rate spread of 50 basis points between the United States and Canada is negatively affecting the Canadian dollar. The Bank of Canada is allowing the spread between U.S. and Canadian interest rates to remain negative so far. It prefers not to follow the Federal Reserve by raising its interest rates and is keeping its bank rate at 4.75 percent to facilitate growth. The Federal Reserve is currently maintaining a 5.25 percent rate in its well publicized attempt to cool down the U.S. economy.

The Canadian dollar alternately weakened and strengthened last week depending upon the markets' shifting views on U.S. interest rates. Now, interest rate spreads and Federal Reserve policy are the primary focus of the market, taking over from commodity prices which had been the day to day driving force of the Canadian dollar.

The U.S. dollar rose against the yen and euro when a weaker than expected U.S. employment report was released. The report implied lower wage pressures. The markets' diminished concern - at least on Friday - that the FOMC is less likely to raise interest rates in October sent stocks soaring. However, the euphoria is sure to pass as the markets begin to focus on the U.S. inflation reports due this week and next.

The dollar fell to new lows last week against the yen, as intervention became less of a threat. The market overlooked weaker than expected data. Japanese economic performance will come into greater focus this week when second quarter gross domestic product is released.

With stronger growth in Europe and Great Britain, policies of the European Central Bank and the Bank of England are coming into focus. Both policy councils meet this week. While analysts are not expecting rate increases yet, the statements following the meetings will be closely studied for hints of future action.

Why U.S. investors care...
Worldwide markets are very sensitive and focused on all things American. Even though many of the world's economies are recovering economically, they have a long way to go - and the United States remains the primary driver of the global economy. In the markets constant inflation watch, commodity prices, especially oil will be monitored carefully. Commodities supply basic inputs to all manufactured and consumer goods. The recent recovery in these prices should make everyone vigilant to inflationary pressures.

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