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Policy Complaisance Hits Euro
Econoday International
Perspectives 1/31/00
By Anne D. Picker, International Economist |
The
euro plunges below parity and stays there
Financial Markets
Volatile
equities
If one had to sum up why
equity markets were so volatile last week, it would be interest rates,
interest rates, and oh yes - earnings. Declines in U.S. markets in the
run up to the Federal Reserve Open Market Committee meeting this week
exacerbated tension in already nervous overseas markets. North American
markets were down while other markets fared better, closing on the plus
side for the week. The exception was Australia, which slid slightly
prior to the Reserve Bank of Australia's policy meeting on Tuesday.
Global markets have been unsettled ahead of the U.S. Federal Open Market
Committee (FOMC) meeting with analysts expecting at least a 25 basis
point interest rate and, at worst, a 50 basis point jump or more.
Selected
World Stock Market Indexes
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|
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Index
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28-Jan
|
21-Jan
|
Week
percent
Change
|
Asia
|
|
|
|
|
Ausralia
|
All Ordinaries
|
3092.10
|
3103.40
|
-0.36
|
Japan
|
Nikkei 225
|
19434.78
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18878.09
|
2.95
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Hong Kong
|
Hang Seng
|
16185.94
|
15108.41
|
7.13
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S. Korea
|
KOSPI
|
941.67
|
925.16
|
1.78
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Singapore
|
Straits Times
|
2284.91
|
2278.48
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0.28
|
|
|
|
|
|
Europe
|
|
|
|
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Britain
|
FTSE 100
|
6375.60
|
6346.30
|
0.46
|
France
|
CAC
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5731.05
|
5681.32
|
0.88
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Germany
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DAX
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7066.60
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6992.75
|
1.06
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|
|
|
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North America
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|
|
|
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United States
|
Dow
|
10738.87
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11251.71
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-4.56
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Canada
|
TSE Comp 300
|
8390.40
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8634.91
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-2.83
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Mexico
|
Bolsa
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6648.48
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6890.78
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-3.52
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Europe
The London FTSE and Frankfurt
DAX indexes sank on Friday after U.S. economic data suggested rising
inflation and increased the likelihood of a steep interest rate increase.
European markets were volatile, upset by interest rate jitters with
large swings each day and from day to day. Earnings concerns and profit
taking also plagued the markets. Promising economic reports were ignored.
But somehow, despite the markets' concerns, the FTSE, DAX and Paris
CAC indexes ended the week higher. The graph below illustrates the inter-day
fluctuations.
On the week, the FTSE inched up 29.2 points
or 0.5 percent to end Friday at 6375.6. The DAX climbed 73.85 points
or 1.1 percent to close the week at 7066.6, and the CAC rose 49.7 points
or 0.9 percent to close at 5731.
The focus on interest rates will remain
sharp next week. The European Central Bank meets on Thursday and the
Bank of England the week after. Analysts expect the Bank of England
to increase rates at that time. Currently, the European Central Bank's
policy setting rate is three percent while the Bank of England's is
5.75 percent.
Asia
Asian markets fluctuated
widely as fears of future U.S. interest rate increases and rising oil
prices weighed on investor decisions. On Saturday, January 23, Japan
convinced its Group of Seven partners that a rise in the yen might kill
the country's fragile recovery.
At the beginning of the week, the Nikkei
celebrated after Japan's G-7 partners (United States, Canada, United
Kingdom, Germany, France and Italy) expressed concern over a strong
yen. However, many market players worried that the G-7 statement expressing
sympathy for Tokyo's concerns about a strong yen was mere lip service
as it did not pledge action to stem the currency's rise.
The Hong Kong Hang Seng index outperformed
everyone last week, vaulting 7.1 percent. But as illustrated in the
graph below, they still have a long way to go before they recapture
the record market highs achieved at New Year's. Hong Kong is very sensitive
to changes in U.S. interest rates.
Currencies
What is left unsaid can sometimes bite Although the final
G-7 statement was sympathetic with Japan about the strong yen, no mention
was made about possible joint intervention by members - and nothing
at all was mentioned about the euro. Traders interpreted the latter
to mean that the European Central Bank was content with a policy of
benign neglect and welcomed the euro's weakening. This gave the euro
new impetus to fall.
It should be remembered that the original
intent of the euro was to facilitate trade by eliminating currency barriers
within Europe. That the euro would challenge the dollar for world supremacy
was part of the rhetoric leading up to its introduction last year.
Foreign exchange traders have
largely ignored further evidence of stronger growth in Europe's core
economies, including an almost 5 per cent year-on-year increase in French
consumer spending and an impressive rise in Italian retail sales. Just
as significantly, the euro has failed to gain from Chancellor Gerhard
Schroeder's plans, announced a month ago, to modernize the German tax
system and accelerate corporate restructuring in Europe's biggest economy.
The European Commission said that the euro's drop against the dollar
and yen gives businesses their best cost advantage since the 1980s.
But others have interpreted the failure
of the euro to gain from the sell off in U.S. stock markets as a sign
of flagging confidence in the pace of reform in Euroland. Also, new
evidence that the U.S. economy continues to outstrip Euroland's performance
put new pressure on the euro, pushing it down to new lifetime lows against
the U.S. dollar. The currency remained well below parity with the U.S.
dollar on Friday, at a new low of $0.9750.
Falling below parity with the U.S. dollar
is a painful psychological blow that could undermine investors' confidence
in the euro. At the start of the year the euro staged a short lived
recovery. However, the currency fell after it became clear to traders
that the European Central Bank, after a meeting of central bankers last
week in Tokyo, had no plans to support the currency.
While the euro's weakness is bound to give
exporters - and the Euroland's economy - another boost, it will drive
up the price of oil imports and it could fuel inflation. Analysts attributed
the euro's poor showing on the financial markets to the strength of
the U.S. dollar and sterling, both of which have been boosted by the
prospect of respective interest rate increases.
Euroland interest rates stand at 3 percent,
making loans cheap for consumers and businesses. In contrast, the British
base rate is 5.75 percent and is expected to rise when the Bank of England
meets again. Similarly, the Federal Reserve is expected to announce
an interest rate increase from its current level of 5.5 percent on Wednesday.
This in turn will make investments in dollars and pounds even more attractive.
Bank
of England sells gold
The gold market barely blinked after the Bank of
England's fourth gold auction on behalf of the British Treasury. The
Bank received $289.50 an ounce down marginally from the $290.00 level,
at which the metal was trading when bidding closed. The Bank is committed
to holding one more auction of 25 tons, planned for March, as part of
its plan to reduce its gold reserves from 715 tons to 300 tons. It has
not said how or when it plans to dispose of the other 290 tons. Tuesday's
auction was 4.3 times oversubscribed, compared with 2.1 times at the
November sale. The price at the UK's first auction on July 6 was $261.20,
and it was 5.2 times covered; in the second auction it was $255.75,
eight times covered; and on November 31 it was $293.50, just over twice
covered. In both the last two auctions big South African mining companies
have been among the successful bidders.
After
the initial UK announcement of its intentions to sell the gold, large
sales of bullion by mining houses and speculators pushed the price gradually
down to just above $250 an ounce last July. But a statement on September
26 by the European central banks that they planned to limit both sales
and loans, prompted a sharp recovery in the price. But during the past
three months the gold price has fluctuated within a band of about $280
to $300 per ounce. It closed this week at $286.55.
The
European Central Bank deliberates Thursday
With the European
Central Bank monetary policy meeting looming on Thursday, data critical
to their discussions were released last week. The first is a measure
of inflation and the second is money growth. Together they are referred
to as the two legs of monetary policy.
December harmonized
consumer price index rose 0.4 percent on the month
and 1.7 percent on the year because of surging in energy prices. December
core inflation - excluding energy, food, alcohol and tobacco - rose
0.1 percent and 1.1 percent on the year. Individual country data show
that the strongest gains in the annual rate were reported for Ireland
(3.9 percent) followed by Austria (1.7 percent). Seven of the 11 EMU
member states posted annual HICP gains of at least 0.3 percentage points,
and six now have annual inflation rates above 2.0 percent.
December M3 money
supply when compared with last year, pushed the three-month
moving average for the October to December period to 6. percent, after
an unrevised increase of 6.0 percent for the September to November period.
This is still substantially above the ECB target of 4.5 percent for
money supply growth.
Getting
ready for the Bank of England's meeting
Important indicators
for the upcoming Bank of England Monetary Policy Committee's consideration
were also released last week, including their key inflation monitor
- the retail price index excluding mortgage
payments (RPIX).
The RPIX increased by 0.2 percent on the
month and 2.2 percent when compared with last year. The all inclusive
retail price index (RPI) rose 0.4 percent on the month and by 1.8 percent
on the year. The retail price index excluding both mortgage interest
payments and indirect taxes (RPIY) rose 0.2 percent on the month and
by 1.8 percent on the year. For 1999 as a whole, RPIX averaged an annual
rate of 2.3 percent, the lowest rate since 1994. Average RPI for 1999
rose 1.5 percent, which is the lowest rate since 1960.
December seasonally
adjusted retail sales volume rose 0.6 percent on the month
and 5.3 percent when compared with last year. Analysts said that the
December data probably reflect additional spending because of the Millennium.
December retail sales showed particularly strong growth in the food
category, which rose 1.8 percent. Alcohol sales were very strong, especially
champagne. Sales of fireworks and jewelry were also strong according
to anecdotal reports from retailers, suggesting a bumper New Year.
Preliminary fourth quarter gross
domestic product at factor cost
rose 0.8 percent and 2.7 percent when compared with last year. The annual
rate of expansion is now at its highest in almost two years. Fourth
quarter service sector output rose 0.9 percent and was up 2.9 percent
when compared with last year. No data for the production sector are
published in this preliminary release. The fourth quarter is the 30th
quarter in succession without a decline, which stretches back to the
end of the 1992 recession. This is the longest period without negative
growth since the 1970's.
Indicator
Scoreboard
Asia
- Japan December retail sales
fell 1.2 percent and wholesale sales fell
3.5 percent when compared with last year. Total retail sales fell 2.9
percent on the year while large scale retailers' sales fell 2.2 percent
or 5.0 percent after adjusting for new stores and stores closing.
December's unadjusted merchandise
trade surplus fell 20.4 percent from a year earlier for the
ninth straight monthly drop. Exports climbed 3.4 percent while imports
gained 15.8 percent. The surplus with the United States slipped 0.1
percent, with exports up 3.5 percent and imports up 7.3 percent. The
surplus with the EU fell an annual 16.3 percent. The surplus with all
of Asia was up 2.2 percent, while the surplus with the Association of
South East Asian Nations dropped 13.5 percent. A provisional release
for calendar year 1999 showed the overall trade surplus down an annual
11.7 percent.
December industrial
production fell a seasonally adjusted 1.4 percent. The fall
came after a rise of 4.5 percent in November. Shipments fell 1.1 percent
and inventories were down 1.6 percent.
Americas
- Canada November retail sales
jumped 0.6 percent on a 3.1 percent gain in the automotive sector. When
compared with a year earlier, total retail sales were 6.1 percent higher.
Excluding sales at motor and recreational vehicle dealers, retail sales
were down 0.5 percent on the month, but up 5.4 percent on the year.
The December Industrial
Product Price Index jumped 0.6 percent. If the exchange rate
had remained unchanged from November to December, the index would have
increased by half as much - 0.3 percent. The 12 month increase hit a
four year high in December because of strong price increases for petroleum
and nonferrous primary metals. Prices for industrial products increased
3.9 percent when compared with last year, the largest year over year
increase since December 1995. The rising value of the Canadian dollar
tempered this increase. If the exchange rate had been the same in December
1999 as in December 1998, the IPPI would have increased by a more substantial
5.0 percent.
Manufacturers paid 33.9 percent more for
raw materials in December 1999 than
they did a year earlier. This is the highest increase since prices for
the Raw Materials Price Index (RMPI) were first recorded in 1981. If
the mineral fuels category, almost all of which is crude oil, were excluded,
the increase in raw materials prices would have been 6.8 percent. Crude
oil prices rose 142.9 percent between December 1998 and December 1999.
For the year 1999 manufacturers paid an average of 7.9 percent more
for raw materials than in 1998. This followed two straight years of
declines in the RMPI, which fell on average 14.5 percent in 1998 and
1.6 percent in 1997. If mineral fuels were excluded from the total,
1999 raw material prices would have decreased 1.1 percent from 1998,
instead of increasing 7.9 percent. Crude oil prices rose an average
36.5 percent in 1999.
The
Bottom Line
ECB
Under Microscope -The
positive economic news out of Europe is being swamped by the currency
markets' myopic focus on up coming interest rate decisions. Contrary
to expectations, the euro did not benefit from the U.S. markets' slide
last week. Rather it hit all time lows.
Analysts say that until ECB policy makers
change their rhetoric and become less complacent about the euro, the
improved growth in the European Monetary Union will be virtually ignored.
The ECB, which meets on Thursday, will hold a press conference at its
conclusion. The markets will be watching - and listening - very carefully
to what is said. With inflationary pressures increasing and the interest
rate spreads between the EMU and the United States and United Kingdom
set to widen, the markets will be looking for an affirmation of euro
support from policy makers. While the lower interest rates are good
for borrowers, the higher rates elsewhere attract investment funds.
Looking
Ahead: Week of January 31 to February 4
Central
Bank Activities |
Feb 1 |
Australia |
Reserve Bank of Australia
Monetary Policy Committee Meeting |
Feb 1, 2 |
US |
Federal Reserve Open Market
Committee Meeting |
Feb 3 |
EMU |
European Central Bank
Governing Council Meeting |
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The
following indicators will be released this week... |
Europe |
Jan 31 |
EMU |
Trade Balance (November) |
Feb 1 |
Germany |
BME/Reuters PMI (January) |
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EMU |
Reuters PMI (January)
Unemployment Rate (November) |
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Italy |
Reuters/ADACI PMI (January)
Consumer Price Index (January) |
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France |
CDAF-Reuters
PMI Index (January) |
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UK |
PMI Manufacturing Survey
(January) |
Feb 2 |
France |
Consumer Sentiment (January) |
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Italy |
Industrial Orders (October) |
Feb 3 |
EU |
Business/Consumer/Industry
Survey (January) |
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UK |
Halifax House Price Index
(January) |
Feb 4 |
Germany |
Manufacturing Orders (December) |
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Asia |
Jan 31 |
Japan |
Housing Starts (December) |
Feb 1 |
Japan |
Unemployment Rate (December) |
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Americas |
Jan 31 |
Canada |
Gross Domestic Product
at Factor Cost (November) |
Feb 1 |
Canada |
Business Conditions
Survey |
Feb 4 |
Canada |
Labor Force Survey (January) |
Release dates are subject to change.
For U.S. data releases, see this week's
Simply Economics.
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