International Perspective By Anne D. Picker, International Economist
Rate Fears, Rocky Week

Financial markets gyrate while waiting for changes in interest rates and G-7.

Financial Markets
The financial markets were uneasy last week with all the major equity markets sinking except for the Toronto Stock Exchange Composite 300. Currencies, especially the yen, suffered from pre Group of Seven "meetingitis". They were wary of what key finance ministers and central bank chairmen might have to say at the conclusion of Saturday's meeting. As it turned out, the communiqué was strikingly similar to the one issued at the September 1999 meeting.

Equities

Europe
Major European markets declined last week, with market participants taking their cues from the Dow, which dropped 2.6 percent on the week. (However, the Nasdaq continued its record setting ways). Investors on Wall Street are increasingly nervous about the prospect of an interest rate hike at the Federal Reserve's February meeting, and the overseas markets have also caught the interest rate worries. Rising crude oil prices are fueling fears of rising inflation and higher interest rates throughout Europe. The graph above shows last week's day-by-day point changes on the London FTSE 100, German DAX and French CAC.

After rising slightly on Monday, the FTSE 100 sank steadily through the rest of the week. The decline was blamed on inflationary pressures from the rising crude prices, which hit a nine year high during the week. The weak Dow put pressure on overseas markets and London markets were no exception. On Thursday, stronger than expected producer prices fueled worries that British interest rates would have to increase yet again. Losses were by no means catastrophic, but the market felt uncomfortable and will continue to feel uncomfortable until the interest rate story is told. The FTSE 100 closed the week at 6346, down 311.9 points or 4.7 per cent.

The global interest rate worries were never far away. Rising bond yields in the United States and elsewhere were interpreted as a signal that interest rates may be going up. Although the European Central Bank, which met on Thursday, voted to leave rates on hold for the time being, analysts expect an increase in February or March. The U.S. Federal Reserve's open market committee meeting scheduled for February first and second is looming, and the Bank of England's monetary policy committee meeting on February ninth and tenth follows shortly after. Dealers say the odds favor U.S. and British increases, with the ECB to follow.

In Paris and in Frankfurt, stocks were mixed on the week. In Paris, the markets suffered a wave of profit taking, particularly in technology and media stocks. The CAC 40 index closed at 5681, down 106 points or 1.8 percent. In Germany, insurers and telecommunication stocks likewise succumbed to profit taking. The DAX index retreated 120 points or 2.5 percent to end the week at 6993.

Asia
All major Asian equity markets ended lower on the week. And although the Nikkei stormed ahead to its highest close in more than two and a half years on Monday (19437), it ended up closing down 78 points or 0.4 percent at 18878 on the week. Technology stocks drove the Nikkei higher on Monday, taking their cues from the Nasdaq's 107 point gain the previous Friday. However, profit taking set in amid uncertainty over the U.S. stock market and on a lack of confidence in Japan's economic recovery. The Bank of Japan's monthly report indicating that the economy is well on the way to improvement failed to rouse sentiment as the strength of the yen exerted additional downward pressure on the market.

Americas

Canada
The Toronto Stock Exchange Composite 300 index (TSE) was the star performer last week, climbing to record setting levels. The TSE jumped 3.3 percent to end the week at 8635. Strong economic numbers including a widening trade surplus and continued low inflation helped. The markets now feel that the Canadian economy is robust enough to withstand a U.S. interest rate increase and a possible matching increase by the Bank of Canada.

Currencies

Euro
The euro continued to struggle despite vigorous pronouncements about the European Monetary Union's promising growth outlook in the run up to the G-7 meeting. The latest drop in the value of the fledgling European currency came despite mounting speculation that euroland interest rates will rise again soon. Further evidence of building European inflationary pressures was provided by German wholesale price data for December, which climbed 3.7 percent when compared with last year. This was the largest annual increase in five years. The euro ended the week at around $1.0090.

In its most recent monthly report, the Bundesbank said that German economic growth is recovering, in part because of the euro's decline against the dollar last year. This helped spur German exports and revive domestic demand. Accelerating growth across euroland is expected to result in higher borrowing costs when, if as expected, the European Central Bank raises interest rates. That could boost the euro by narrowing the yield advantage that U.S. fixed income securities enjoy relative to European debt.

Group of Seven meeting...
The Group of Seven (United States, Canada, United Kingdom, France, Germany, Italy and Japan) finance ministers and central bank leaders met Saturday in Tokyo. Russia took part in the talks relevant to it. Unlike the communiqués of the last two years when the Asian financial crisis and its rippling effects were the primary subjects, this time the G-7 was optimistic on world growth and inflation. In their statement, the participants ignored the sinking euro much to the delight of the Europeans and did not emphasize the strength of the yen as the Japanese had been looking for. Rather, their statement said pretty much the same thing as after the September 1999 meeting: They shared Japan's concern about the strengthened yen on the Japanese economy but there was no sign that there would be any concerted effort on the part of G-7 to help push the yen's value down. The Bank of Japan has been fighting a losing battle to weaken the yen over the past six months. The Bank, at the request of the Ministry of Finance, intervened in the currency markets 13 times in the last six months in efforts to weaken the yen, without too much success.

Central bank activities...
European Central Bank - the Bank left all its official rates unchanged following its regular Governing Council meeting Thursday. The ECB last raised rates by 50 basis points to three percent on November 4, 1999.

Bank of Japan - The Bank of Japan's Monetary Policy Board decided to leave its monetary policy unchanged after a regular meeting Monday. The current interest rate is effectively zero.

Indicator scoreboard...

Germany
December wholesale prices jumped 0.9 percent on the month and 3.7 percent when compared with last year, largely due to higher oil prices. This second consecutive strong monthly increase indicates that price pressures are increasing in Germany. When compared with last year, the December jump in wholesale prices was the strongest since April 1995. The index excluding petroleum products rose 0.4 percent on the month and 0.9 percent on the year.

Industrial productivity per employee and per hour worked in manufacturing and mining industries both declined in November. Seasonally adjusted productivity per employee also fell 0.3 percent from October but was 3.5 percent above the year earlier level.

December's Ifo Institute's west German business sentiment index climbed for the seventh time in the last eight months, reaching the highest level in two years. The December reading rose to 99.6, but was below market rumors of an index level over 100. East German business sentiment also improved in December, with the index jumping to 105.3 from 104.1. The east German index bodes well for future pan German growth.

November pan German real, seasonally adjusted construction orders fell 8.1 percent on the month and were down 10.6 percent when compared with a year earlier. The data confirm concerns that the construction sector has not yet hit bottom and is likely to continue to drag overall growth down in the fourth quarter. The drop was due solely to weakness in the west, while demand increased slightly in the east.

Italy
November industrial production rose a seasonally and workday adjusted 1.1 percent over October boosted by strong output of construction and transportation goods. This is the first concrete and reliable sign of output recovery. It was widespread with almost all sectors participating, and reflects the recent trend of improved orders since last June.

France
November manufacturing output surged up 1.8 percent for an annual gain of 5.7 percent, according to seasonally and workday adjusted data. The largest monthly gains came from consumer and semi finished goods, both up 2.6 percent, followed by capital goods, up 1.5 percent.

Britain
November industrial production rose by 0.4 percent on the month and by 2.1 percent on the year, the highest growth rate since July 1997 when it stood at 2.5 percent. The news is a further sign that the economy is recovering rapidly from its slowdown last winter and is poised for strong growth in 2000. November manufacturing output increased 0.6 percent on the month and 2.2 percent when compared with last year. The manufacturing sector recovery has raised its annual rate of growth to its highest level in almost five years. Manufacturing, which had been the weakest section of the economy, is growing at a trend rate of 3.5 percent - faster than the larger services sector.

Average earnings growth remained steady in the three months to November although the rate of increase is still likely to cause concern to the Bank of England. Earnings growth in the three months to November was 4.9 percent higher than in the same three months a year ago, and equaled the increases of the previous three months.

December producer prices rose 2.3 percent on the year and 0.3 percent on the month. This is the highest rate of producer price inflation for three years. The jump was driven by the rising cost of fuel and raw materials bought by manufacturers. Excluding volatile items such as oil, output prices rose by only 0.4 percent on the year and were unchanged on the month. Input prices, the price of raw materials and fuels entering the factory, soared 12.1 percent on the year - the fastest rate of increase in five years. Crude oil prices now stand 164.8 percent higher than a year ago, the biggest jump since records began in 1974.

Americas

Canada
November factory shipments leaped 1.8 percent led by increases in electrical and electronic products and wood, while unfilled orders slipped 0.4 percent. Factory shipments were up in 17 of 22 major groups, representing 71.7 percent of the total. Unfilled orders fell 0.4 percent, the first decrease after six consecutive months without a decline. The drop was mainly attributed to motor vehicles (down 5.4 percent) and aircraft and parts (down 1.0 percent).

The November merchandise trade balance rose to C$3.1 billion, its highest level since July 1999. This follows a strong third quarter, where merchandise trade contributed to the first positive balance of the current account since the last quarter of 1996. Down 0.2 percent, imports edged lower for the first time since January 1999, due primarily to lower imports of computers, compressors, telecommunications equipment and cattle. Exports rose 1.4 percent to a level almost as high as the August 1999 record mainly the result of strong exports of high tech products, in particular nuclear, electronic and aeronautics products, as well as of minerals and natural gas. The trade surplus with the United States rose to C$5.798 billion from a revised C$5.194 billion in October. Canada posted a deficit of C$261 million with Japan, a decline from the revised C$144 billion deficit in the prior month. All other countries also showed a deficit.

December consumer price index crept up 0.1 percent, but jumped 2.6 percent when compared with last year. Excluding energy and the volatile food component, the core measure dropped 0.1 percent in the month. This left the year over year rate for core prices unchanged and lower than expected at 1.6 percent. Thus inflation remains in the bottom half of the central bank's target range of 1 percent to 3 percent.

End note...

The interrelationships between global markets were easily observed last week. When the Dow fell markets in Asia and Europe followed suit. The Group of Seven continues to look for more balanced growth between Europe, Asia and the Americas. And as the indicators above show, things are improving in Europe. However, growth without the necessary structural changes in the labor markets and fiscal policies will put a lid on how fast and how far the European economies can run. Yet the changing environment since the inception of the euro - and its subsequent weakness - has benefited European exports and domestic demand.

Looking ahead...

Release dates are subject to change.

For U.S. data releases, see this week's Simply Economics.