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Interest
rate indigestion = market heartburn
The FTSE 100 had a wobbly week - falling one day and rising the next. A host of indicators important to monetary policy were released (see below) and studied for their policy implications. Many analysts have concluded that the Bank of England will probably not raise rates at their June meeting. At week's end, the FTSE stood at 6045.4, down 238.1 points or 3.79 percent. European markets also were uncertain about the performance of U.S. markets and interest rates. But the European Central Bank, in its monthly report, posed no mysteries - the ECB would be raising interest rates again and soon. The spread between U.S. and ECB rates is now 2.75 percent. Despite the prospect of higher interest rates, the euro fell anyhow... A very favorable German Ifo survey of business sentiment failed to catch market players' attention as the ebb and flow in U.S. markets preoccupied equities. The markets gyrated accordingly. The Frankfort DAX was down 280.25 points or 3.86 percent to end the week below the critical 7,000 mark at 6989.03. The Paris CAC was down 253.22 points or 3.93 percent on the week to end at 6196.05. Asia The Nikkei 225 fell through the 17,000 mark. Auto manufacturers are concerned that higher U.S. interest rates will curtail automobile exports. The index continued to suffer from the internal component changes of a few weeks ago along with continued flows out of the market. Foreigners especially are worried over more U.S. rate increases, and have pulled money out of Japan where interest rates are virtually zero.
Foreign investors were net sellers of Japanese equities in the week ended May 12, according to the Tokyo Stock Exchange. They sold 496 billion yen ($4.5 billion) more in shares than they bought in the Tokyo, Osaka, and Nagoya exchanges between May 8 and May 12. In April, foreigners sold a net 846 billion yen of shares, the highest since September 1998. The Nikkei 225 lost 499.69 points or 2.88 percent on the week to close at 16858.17, the lowest since September 1999. The Hong Kong Hang Seng index was the victim of profit taking in blue chips, but China-related shares surged on hopes that Beijing would forge a trade deal with the European Union, the biggest remaining obstacle to China's membership in the World Trade Organization. Those hopes were realized after the market close on Friday when China and the European Union inked a bilateral agreement.
U.S. rates especially worried market participants in Hong Kong. Hong Kong's currency is pegged to the U.S. dollar, so changes in U.S. monetary policy almost always prompt equivalent changes in Hong Kong rates, even though the two economies' business cycles often diverge. The Hang Seng was down 652.19 points or 4.31 percent to end the week at 14,478.26. The Hong Kong Association of Banks raised its key deposit rates 50 basis points to 4.75 percent at its Friday meeting. Americas
Currencies
BoJ's Hayami said that there had been a recovery in private demand and that the central bank was not committed to a zero interest rate policy. The bank maintains a near zero percent target for the benchmark overnight lending rate, compared with the 6.5 percent U.S. rate. Higher Japanese rates could give investors there more incentive to keep funds at home, which would soften demand for the dollar and the euro. The euro remains stuck in the $0.89 to $0.91 range despite relatively favorable German economic news and continued positive rhetoric from ECB officials. The euro has been sinking against the yen as well. The skeptical foreign exchange markets continue to wait for definitive news on a variety of issues, especially much needed structural reforms. These include making the labor markets more flexible and tackling bloated state pension systems as well as moves to reduce high tax rates.
The interest rate differential between the United States and Europe - now 2.75 percent - has contributed to the decline of the euro, which is down 25 percent since its January 1999 launch. In part because of the differential, European investors have poured around $150 billion into the United States over the past year, while only a small fraction of that amount has headed back the other way. The decline has raised import costs and is contributing to inflationary pressures. Point/counterpoint
- the Fed raises interest rates
In other central banks
- The Bank of England released the minutes for their Monetary Policy Committee meeting on May 3rd and 4th. Among the key points, the MPC voted unanimously to leave their policy making repurchase rate unchanged. The MPC was split on whether this is likely to be the peak of the current cycle. However, some committee members were very concerned about the strength of domestically generated inflation pressures, reflecting the tight labor market and still buoyant final domestic demand growth. The European Central Bank's May monthly report contained very hawkish language, suggesting that the central bank will raise official rates at least once in the period ahead. The ECB warned that the latest M3 money supply data and the euro's continued weakness make clear that inflation risks continue to persist. The ECB wrote that the euro's exchange rate has moved further out of line with the increasingly positive economic fundamentals of the European Monetary Union and its balance of international payments. Indicator
Scoreboard April harmonized index of consumer prices rose 0.1 percent on the month and 1.9 percent when compared with last year. However, the annual rate for core inflation - excluding energy, food, alcohol and tobacco - rose 0.2 percent to 1.3 percent. The monthly rise in the overall HICP was mainly due to a surge in prices for food, alcohol and tobacco. Energy prices declined 1.1 percent on the month but were still 10.5 percent above April 1999 levels.
Germany - March seasonal and calendar adjusted retail sales dropped 2.0 percent on the month and 4.5 percent on the year. Bundesbank data for calendar adjusted real sales excluding auto and gas stations were down 1.8 percent on the month and 3.9 percent on the year. Motor vehicle sales fell 2.9 percent in March and 5.6 percent when compared to a year ago. April wholesale prices declined 0.4 percent on the month but rose 4.8 percent when compared with last year. The decline was led by petroleum product prices, which fell 5.2 percent on the month. Fish product prices also dropped sharply, down 8.9 percent. The April Ifo Institute's west German business sentiment index rebounded to 101.2 after March's unexpected decline. The April index level was the highest since April 1991. East Germany business sentiment also rose in April, up to 109.0 from 107.2 in March. Increases in both sentiment on current conditions and on business expectations contributed to their rise.
France - March seasonally adjusted merchandise trade surplus widened slightly in March, as exports continued higher while imports contracted further. The surplus was E1.150 billion, up E191 million from February. March seasonally adjusted exports rose 0.5 while imports fell back 0.3 percent. First quarter non-farm jobs rose 1.0 percent on the quarter and 3.1 percent on the year. Services sector jobs rose 1.3 percent on the quarter and 4.2 percent on the year. The construction sector added 1.0 percent on the quarter and 2.9 percent on the year, and industry added 0.4 percent on the quarter and 0.7 percent on the year. Britain - Key economic indicators that are important to rate policy were released last week in addition to the latest Bank of England Monetary Policy Committee minutes. The bottom line is that other factors such as the strength of the pound sterling will play major roles when the MPC meets next on June 6th and 7th. April retail price index excluding mortgage interest payments (RPIX) rose 0.7 percent on the month and 1.9 percent when compared with last year. This is the 13th consecutive month that the RPIX has remained below the Bank of England's 2.5 percent inflation target. The April retail price index rose 1.0 percent on the month and was up 3.0 percent on the year The retail price index excluding both mortgage interest payments and indirect taxes (RPIY) rose by 0.1 percent on the month and was up 1.6 percent on the year.
Average earnings grew by 5.8 percent in the period from January to March, compared to 6.0 percent over the December to February period, as millennium bonuses began to drop out of the data. Although the growth in average earnings slowed slightly from previous months, wages are still rising rapidly and much faster than the Bank of England would like. The Bank of England has said that any increase in wages above 4.5 percent is incompatible with its inflation target of 2.5 percent.
April claimant count unemployment rate tumbled to 3.9 percent, the lowest since January 1980. The International Labor Organization (ILO) unemployment rate remained unchanged at 5.8 percent for the first three months of the year. But the regional divide between North and South remains strong, with unemployment in the northern region nearly three times higher than unemployment in the southeast. Total employment in manufacturing dipped below four million in March for the first time in over six years as manufacturers continued to cut back.
April retail sales volumes dropped by 0.3 percent on the month but were still up 4.5 percent when compared with a year earlier. Retailers across all sectors said that the extremely wet weather in April depressed sales. Sales in the latest three months were up 0.2 percent on the quarter and up 4.5 percent on the year.
Asia Americas April seasonally adjusted consumer price index fell 0.3 percent. When compared with last year, the CPI rose 2.1 percent. The decline was largely attributable to the decrease in energy prices. The CPI excluding food and energy index edged up only 0.1 percent in April and 1.3 percent when compared with last year. The Bank of Canada's inflation target range is 1 to 3 percent. March retail sales jumped 2.1 percent. Automotive sales soared 4.3 percent. When motor and recreational vehicle dealers are excluded, total retail sales advanced 1.0 percent in March. March merchandise trade surplus rose to C$3.9 billion. This, combined with strong balances in January and February, made for an overall surplus of C$11.7 billion for the first three months of 2000. This first quarter surplus was the second highest quarterly surplus overall, just short of the record of $12.1 billion in second quarter 1996. Exports jumped 4.5 percent from February, as the crucial automotive industry recovered from a temporary slowdown in production. Imports rose 3.7 percent, halting two consecutive monthly declines. The key imports were electronic products, automotive parts, tools and equipment, and energy products.
BOTTOM LINE The European Central Bank meets three times before the next FOMC meeting, including this Thursday. The ECB is giving every indication that a rate hike is in its future, with most analysts betting on June. Clearly, the 2.75 percent interest rate spread between EMU and the United States is not desirable because investors follow the higher returns. As noted above, outflows of investment to the United States only weakens the euro more. And this increases the likelihood of higher inflation, the ECB's number one enemy.
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