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Will
the ECB's rate hike stymie EMU's economic growth? At week's end a great debate was shaping up, whether the European Central Bank had raised rates more than the European economies can bear. The 50 basis point jump shocked the markets. And certainly the economic performance numbers will be scrutinized even closer. Investors will be watching for any signs of weakness. Meanwhile, the jury is still out...
Britain and Europe
In Britain, the FTSE 100 seemed to run out of steam after its superlative performance in the prior week. A dose of profit taking was behind the decline in London's benchmark index. Low volume indicated that institutions were holding back until after the Bank of England's interest rate decision on Wednesday. As expected, the bank's monetary policy committee left interest rates on hold at 6 percent. But the FTSE 100 faltered on news of a surprise rise in European interest rates. At week's end, the FTSE 100 stood at 6443.8, down 182.6 points or 2.76 percent. News that the European Central Bank had lifted European Monetary Union interest rates by 50 basis points came as a considerable shock to European markets, which had priced in a 25 basis points rise. Both the Paris CAC and Frankfurt DAX lost ground with the CAC ending the week at 6549.05, down 124.47 points or 1.87 percent while the DAX lost 184.42 points or 2.48 percent to close at 7254.53. Asia
The Nikkei 225 struggled to remain about even on the week. Anxiety about first quarter gross domestic product contributed to the downside. Gross domestic product rose by 2.4 per cent on the quarter against predictions of a 2.8 per cent rise. A market pundit noted that this was the fastest growth since the last leap quarter in 1996, which adds an extra day to the quarter. The Nikkei remains nervous about the insurance company failures of recent weeks along with the political uncertainty from the June 25th election. The Nikkei 225 ended the week at 16,861.91, up 61.85 points or 0.37 percent. The South Korean Kospi outperformed the markets tracked here, jumping 9.95 percent or 75.71 points, to end the week at 826.40. Stocks rose on optimism that deregulation of the financial industry will accelerate following a report of a major bank merger. Foreign demand was strong. Construction shares also were in favor on expectations that next week's historic inter-Korean summit would help boost business for construction companies. Currencies
The euro increased in value against the major currencies building up to Thursday's rate increase, which was expected to narrow the spread between EMU rates and those in the United States and Britain. A shrinking rate gap would make euro deposits more attractive, prompting investors to shift more funds to euros. The currency soared initially when the 50 basis point interest rate increase was announced. However, it slithered downward as market players began to have second thoughts and became worried about the rate increase's impact on economic growth. The euro had gained in the last two weeks as upbeat economic reports reinforced expectations of an ECB rate increase. However, after the initial euphoria, the market started to worry this might stifle the upswing in some of the member countries and by week's end the euro had fallen. Higher borrowing costs could hurt company profits, which would slow economic expansion and business investment. Now the debate is beginning in earnest. Investors are wondering if the ECB is being overly aggressive with its monetary tightening. Although European economies are accelerating, they may not be able to withstand an aggressive approach to interest rates. The yen rose in the early part of the week as a rebound in Japanese stocks sparked optimism that demand for shares would bolster the currency and on expectations of a strong gross domestic product report on Friday. Tokyo markets rose sending the Nikkei 225 stock index up and generating demand from international investors for yen to buy shares. This however, was short lived and the Nikkei oozed down taking the yen with it.
The yen was also helped by a capital spending report that bolstered optimism for Japan's illusive recovery. That in turn sparked speculation that the Bank of Japan may move away from its current zero interest rate policy and raise rates. This could persuade Japanese investors to keep more money at home. But the yen fell, especially after GDP was reported to have grown more slowly than expected. This dashed hopes that the Bank of Japan would be able to abandon its zero interest rate policy and raise Japanese interest rates from near zero percent. Central
Bank Activities The European Central Bank surprised the markets and raised its policy making refinance rate 50 basis points to 4.25 percent. The markets had expected a 25 basis point increase. The ECB last raised its rates on April 27th when it hiked the rate by 25 basis points to 3.75 percent. The refinancing rate is the interest the ECB charges commercial banks for buying back short term securities when banks need cash.
The ECB also raised two other rates, which form the floor and ceiling for the money market, by 50 basis points. The overnight deposit rate was increased to 3.25 percent and the marginal lending rate was raised to 5.25 percent. The overnight rate is the interest paid by the ECB to banks when local banks deposit excess money with the central bank. The marginal lending rate is interest paid by banks to the ECB, when they need quick emergency loans. The move has been controversial, because analysts are concerned that the rate hike might be too strong for the newly growing economies to absorb. Indicator
scoreboard
The May European Commission's economic sentiment index for the 11 EMU states was steady for the third month in succession, although both consumer and industrial sentiment improved in the reporting month. The overall index stood at 104.0, unchanged from the unrevised readings in April and in March. A national breakdown of the latest data shows that overall economic sentiment rose in four of the 11 EU countries - Germany, France, Portugal and Finland - and fell in four - Spain, Ireland, Italy and Austria.
April industrial producer prices, excluding construction, rose 0.1 percent on the month and 5.7 percent on the year after having increased a revised 0.7 percent on the month and 6.2 percent on the year in March. The main factor behind April's strong overall PPI jump was a 0.4 percent monthly and 9.8 percent annual increase in intermediate goods prices. This category contains prices for oil and other commodities, which have been strongly affected by the weak euro. First quarter preliminary gross domestic product rose 0.7 percent on the quarter and 3.2 percent on the year. First quarter growth was led by a sharp rise in investment as well as stronger government spending. However, private consumption was flat. The net exports were 2.1 percent of GDP. Gross fixed capital formation jumped 2.1 percent. First quarter domestic demand rose 0.7 percent after a 0.6 percent rise in the previous quarter.
Germany - April seasonally adjusted manufacturing orders increased 2.5 percent from the previous month as a sharp rise in domestic demand offset a slight decline in foreign orders. Domestic orders were up 4.6 percent on the month, while foreign orders declined 0.5 percent. April east German manufacturing orders surged 12.7 percent mainly due to increased capital goods orders while west German orders rose 1.6 percent. April pan-German industrial production rose 1.5 percent. The rise was led by a 1.8 percent gain in manufacturing production. In west Germany, April output rose 1.5 percent while in the east, output was up 3.5 percent on the month. May seasonally adjusted pan-German unemployment rate was steady at 9.6 percent in May. The rate in the west declined to 7.7 percent from 7.8 percent, while that in the east was unchanged at 17.3 percent. Britain - May Halifax house prices fell a seasonally adjusted 0.4 percent on the month but rose 11.2 percent when compared with last year. The annual rate slowed from 14.2 percent in April. This is the third slight fall in the monthly rate in the past four months. The Halifax said the slowdown in house price growth appears largely to be in response to four mortgage interest rate increases since last September and the abolition of mortgage interest tax relief in April.
Total housing starts in the three months to April fell a seasonally adjusted 3 percent compared with the previous quarter and fell 3 percent on the year. Total completions in February to April rose 2 percent on the previous quarter and 2 percent on the year earlier. April industrial output rose 0.8 percent and was up 2.2 percent when compared with last year because cold weather boosted demand for electricity and gas. March data were also revised up, with industrial output increasing by 0.8 percent and by 1.5 percent when compared with last year. April manufacturing output fell by 0.2 percent on the month but was still up 1.6 percent on the year. March manufacturing output climbed 0.6 percent on the month and 1.7 percent when compared with last year. Asia
First quarter business investment rose 3.3 percent when compared with last year, the first gain in nine quarters. Capital spending in the manufacturing sector, however, dropped 6.1 percent, declining for the seventh consecutive quarter. First quarter corporate pretax profits for all industries jumped 38.7 percent from a year earlier, following a 41.8 percent rise in the previous quarter. Overall sales rose 2.6 percent during the period, after registering a 2.2 percent gain in the previous quarter. May domestic wholesale prices rose 0.1 percent and were up 0.3 percent when compared with last year. Prices of non-ferrous metals led the increase while petroleum and coal products and machinery decreased. May export price index decreased 0.3 percent on the month in terms of contract currencies but was up 1.3 percent in yen terms but down 7.6 percent on the year in terms of the yen. May import price index was down 1.0 percent in terms of contract currencies but rose 1.0 percent in yen terms and was up 0.8 percent from the previous year in yen terms. April key private sector machinery orders received by Japanese manufacturers fell a seasonally adjusted 1.1 percent. The key orders are viewed as a leading indicator of corporate capital investment six to nine months ahead. Total orders fell 1.9 percent from the previous month, seasonally adjusted, while private sector orders rose 4.7 percent. Manufacturing machine orders rose 9.3 percent on the month. Americas May unemployment rate dropped 0.2 percentage points to 6.6 percent, the lowest since March 1976. Employment rose an estimated 42,000. When compared with last year, the number of jobs has risen 2.8 percent. All of the employment gain was in the private sector, where the estimated number of employees increased by 32,000 and the number of self-employed rose by 30,000. Job gains among private sector employees are up 4.2 percent from May 1999, continuing an upward trend that began about three years ago.
BOTTOM LINE In Europe, debate whether the 50 basis point interest rate increase was appropriate will continue. Investors will be looking more closely for fault lines in new economic data. With the other major central bank meetings over, the markets will focus with full intensity on the United States. The countdown to the Federal Open Market Committee Meeting will begin in earnest with the release of the Federal Reserve's Beige Book on Wednesday. Since the weak employment report on June 2nd, investors' moods have vacillated between optimism that the Fed will not have to raise interest rates anymore to the prospect that more rate increases are on the horizon.
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