US 4th quarter GDP revised up, data from Europe and Japan mixed

US fourth quarter GDP growth has been revised upward again. From Reuters:

Gross domestic product increased at a 1.7 percent annual rate in the fourth quarter -- slightly up from 1.6 percent estimated a month ago and in line with forecasts -- but sharply down from the third quarter's 4.1 percent pace, the Commerce Department said...

An inflation gauge frequently cited by the Fed -- the price index for personal spending excluding food and energy -- was revised to a 2.4 percent rate of annual increase in the fourth quarter from 2.1 percent rise estimated a month ago. That was well ahead of the 1.4 percent rate in the third quarter...

Profits after taxes surged in the fourth quarter as the impact of uninsured losses from the hurricanes waned. Businesses posted a 13.8 percent increase in after-tax profits following a 4.3 percent decline in the third quarter...

The rate of growth in consumer spending...slowed sharply in the fourth quarter, growing at a 0.9 percent pace...just a fraction of the 4.1 percent rate of increase for spending in the third quarter.

Meanwhile, the labour market continues to improve.

Separately, the Labor Department reported that new claims for U.S. jobless benefits fell 10,000 last week to 302,000 from an upwardly revised 312,000 in the prior week, implying a resilient jobs market.

The labour market looks less rosy in Germany, with the number of jobless, adjusted for seasonal swings, rising by 30,000 to 4.73 million in March, the second increase in three months, and the jobless rate rising to 11.4 percent from 11.3 percent.

France's unemployment rate, on the other hand, was unchanged at 9.6 percent in February, but consumer confidence did fall to minus 26 in March from a 10-month high of minus 24 in February.

In the UK, data from the Nationwide building society show that house prices rose 1.1 percent in March or 5.3 percent over the previous year -- the biggest annual increase since May 2005 -- after a 3.7 percent gain in February.

The news from Japan recently has been mixed. The trade ministry reported yesterday that industrial output fell 1.7 percent in February, the first drop in seven months, but today's reports were somewhat better.

Japan’s unemployment rate has dropped to its lowest level in more than seven years... The jobless rate fell to 4.1 per cent in February from 4.4 per cent in the previous month, according to government figures published on Friday. The number of unemployed people fell by 210,000 in the month, with an increase of 240,000 in the number of people in a job. The jobs-to-applicants ratio rose to 1.04, a 14-year high...

Core consumer price inflation remained stable in February at 0.5 per cent – confounding a consensus forecast that it would rise slightly.

But Takuji Aida, chief economist at Barclays Capital Japan, said inflation would continue rising, leading to expected increases in interest rates later this year...

Other figures published on Friday showed a 1.5 per cent year-on-year fall in household spending in real terms, although spending was up 0.2 per cent from January after adjusting for seasonal variations.

German consumer confidence high, Japanese retail sales fall, worrying data from UK

There was no major economic news from the US yesterday, but plenty elsewhere.

In Germany consumer confidence is high.

GfK's confidence index, based on a March survey of about 2,000 people that aims to forecast household spending one month ahead, climbed to 5.1, the highest since December 2001, from 5.0 in the previous month, the market-research company said in an e-mailed statement today. Households also became more optimistic about spending money in coming months, the survey showed.

Meanwhile, Japanese retail sales fell in February, but by less than expected. Bloomberg reports:

Retail sales fell a seasonally adjusted 1.5 percent from January, the Ministry of Economy, Trade and Industry said in Tokyo today. That was less than the median forecast for a 2 percent drop in a Bloomberg survey of 5 economists. Sales from a year earlier rose 1.0 percent, beating a median 0.8 percent forecast of 21 economists surveyed.

There was plenty of news from the UK yesterday, mostly negative. From Reuters:

Britain posted its biggest current account deficit in six years in 2005... official figures on Wednesday showed the current account gap in the fourth quarter alone was nearly double expectations at 11 billion pounds, or 3.6 percent of gross domestic product.

That left the deficit for the year as a whole at a record 31.9 billion pounds or 2.6 percent of output, the highest such ratio since 1999.

GDP growth in the fourth quarter was unrevised at 0.6 percent in final data but the figures showed a big drop in the saving ratio to 4.8 percent as consumers financed spending while their incomes remained static...

The Confederation of British Industry's monthly retail survey, also out on Wednesday...showed sales volumes falling at a much sharper than expected pace as cold weather kept shoppers away...

Adding to Wednesday's gloom, the Bank of England reported that mortgage approvals, a leading indicator of the housing market, fell for the first time in nearly 1-1/2 years in February.

The loan agreements fell to 115,000 from 121,000 in January while mortgage lending rose by 8 billion pounds, nearly a billion less than expected, in a possible sign that the housing market recovery is losing steam.

Fed funds rate rises, as do US consumer and German business confidence

The US consumer remains confident, and so, apparently, is the Federal Reserve. Reuters reports:

[T]he Conference Board, a private research firm, said its measure of consumer sentiment jumped to 107.2 from an upwardly revised 102.7 in February, beating Wall Street forecasts of only a modest gain...

Reflecting the robust economy, the FOMC unanimously agreed to lift its rate target on federal funds, overnight loans between loans, to 4.75 percent from 4.50 percent.

While long-term U.S. inflation remains low, a tightening labor market and stubbornly high energy prices could add to inflation pressures, according to the statement issued by the FOMC after the meeting...

A report on regional business activity from the Richmond Fed showed a sharp rise in March. Its monthly composite manufacturing index rose to 21 in March from zero in February. New orders and shipments rose, as did the number of employees in the Fed's fifth district.

Retail sales, though, did not match the improvement in sentiment.

Sales fell 1.6 percent in the week ended March 25 after prior week's 0.1 percent dip, said the International Council of Shopping Centers and UBS Securities LLC... Sales gained 2.2 percent on a year-over-year basis for the week ended March 25, following a 2.5 percent rise in the prior week, according to Redbook.

While the Federal Reserve has been busy raising rates, the Bank of England has been standing pat on rates. Yesterday, it explained why.

Bank of England policymakers signalled on Tuesday they are in no hurry to move interest rates in either direction as risks to inflation are balanced and the overall outlook remains benign.

On the continent, the risks appear to be mainly to the upside. From FT:

German business confidence surged to a 15-year high in March and eurozone credit growth accelerated strongly last month, boosting the case for an early increase in European Central Bank interest rates...

The jump in the Ifo index – from 103.4 in February to 105.4 – coincided with ECB figures showing eurozone lending to consumers to buy houses rose in February at the fastest annual rate since late 1999. Lending to eurozone companies rose at its fastest pace since early 2001...

Italian business confidence also hit a five-year high, according to separate data on Tuesday.

Expectations moderate in Japan and China, Euro-area economy "on track"

Business confidence moderated in Japan in the current quarter. From AFP/CNA:

The business sentiment index for large companies fell to 6.1 in the three months to March from a record high 10.5 in the previous quarter, according to a joint survey by the finance ministry and the cabinet office.

The index is expected to recover to 8.3 in the June quarter and to 11.3 in the three months to September, according to the survey of 14,301 firms, of which 11,300 replied.

This is occurring as the Japanese government tightens its belt.

The budget reduces spending for the fiscal year to March 2007 by three percent to 79.69 trillion yen (US$686 billion), the first drop for four years and the first time below 80 trillion in eight years...

Despite the cut in bond issues and spending, national debt held by the central and local governments is expected to grow to 775 trillion yen by March 2007 from 770 trillion yen at the end of March 2006, and 410 trillion in 1995.

China's economic growth is expected to slow this year. Also AFP/CNA:

China's growth rate is forecast to slow throughout the year, with gross domestic product (GDP) to rise 9.2 percent in the first quarter and 9.0 percent in the second quarter, a central bank report said Monday.

Growth will slow further to 8.9 percent in the three months to September before falling to 8.7 percent in the final three months of the year...

The report, published by the central bank research bureau in the official China Securities Journal, also predicted that inflation would increase to about 2.0 percent this year, in line with most analysts' forecasts.

French business confidence also declined in March, although from a 17-month high in February. Meanwhile, the European Commission is confident that euro-area recovery remains on track.

Euro-area economic growth is expected to have rebound during the first quarter and remains on track to reach 1.9% in 2006 after a slowdown in the last three months of 2005. Most encouraging is the outlook for private investment which has been on a clear recovery since the spring last year and should continue to expand in the months to come. Private consumption is also expected to pick up in the course of 2006 following a strengthening of consumer confidence since the summer of 2005 and a progressive improvement in employment. The outlook for exports is also positive, reflecting improved cost competitiveness of the euro area and a continued rapid expansion of world trade. These are the conclusions of the first Quarterly Report on the Euro Area for 2006.

The Quarterly Report did highlight concerns over rising house prices and household indebtedness. Speaking of which, the housing market in the UK is looking up again, with mortgage approvals rising in February before seasonal adjustments and house prices rising in February on a year-on-year basis for the first time since January 2005 according to property consultant Hometrack.

US housing market flashes warning on economy

One of the widely acknowledged risks to the global economy has been the global housing market. Thanks to low interest rates worldwide, this market has boomed over the past few years, boosting economic activity as well as fuelling consumer demand through home equity withdrawal. There are signs, however, that this boom may not last much longer.

While house prices had moderated earlier in places like the United Kingdom and Australia, the housing market in the United States, the main source of global demand, had seemed impervious to the slowdown. Until recently that is.

On Friday, the US Commerce Department reported that sales of new single-family homes in February were down 10.5 percent over that in January, the biggest fall since 1997. Median home prices fell as well -- the fourth consecutive month of decline -- hitting US$230,400 in February, the lowest level since July 2005.

While sales fell, the number of new homes available for sale rose 4.4 percent to an all-time high. At the current rate of sales, the number of new homes would take 6.3 months to sell, representing the longest period since January 1996. This inventory of new houses that has built up is likely to put downward pressure on house prices in the coming months.

In view of housing's role in influencing consumer demand, many economists fear that the weakening housing market is flashing a warning signal on the economy. They fear that the weakness in the housing market may be the prelude to a slowdown in consumer spending and a possible recession.


The chart above shows past downturns in consumer spending and recessions associated with declines in new home sales. As can be seen, recessions have often occurred when new home sales have declined sharply -- in the order of 20 percent or more on a year-on-year basis at the trough.

The last recession in the US was in 2001. However, that recession was not associated with a large decline in new home sales, and real consumer spending did not turn negative on a year-on-year basis.

The last time new home sales saw declines of around the magnitude seen in earlier recessions was in 1994-95. That decline, however, was not followed by a recession, and consumer spending stayed positive during that period as well.

The latest fall in new home sales is close to but has not quite hit the extent in 1994-95. Not yet at least. Since the US economy escaped a recession in 1994-95, it seems reasonable to argue that it is premature to conclude that the latest new home sales number indicates an impending recession.

One caveat though. Back in 1994-95, real estate assets held by households and non-profit organisations in the US totalled an amount equivalent to less than 117 percent of GDP. Today, it represents about 170 percent.

Clearly, a lot more is riding on housing this time around.

Renewed signs of weakness in US economy, better signs from Japan and Germany

The positive numbers on existing home sales in the US was not repeated in new home sales. Reuters reports:

Sales of new U.S. homes took their biggest plunge in February in nearly nine years, while prices fell and the number of homes for sale hit a record high, signaling significant slowing in the housing market.

Sales of new single-family homes were down 10.5 percent, the government reported on Friday...

According to the Commerce Department, the pace of new single-family home sales slowed to a 1.080 million unit annual rate in February from January's downwardly revised 1.207 million unit rate...

While new home sales slowed, supply surged. The number of new homes available for sale climbed to a record 548,000 by the end of the month. At the current sales pace, that represents 6.3 months' supply -- the largest inventory of new homes since January 1996, the government report showed.

Median home prices declined for the fourth month in a row, hitting $230,400 in February, the lowest level since July 2005.

The Reuters report also highlights strong overall durable goods orders but weak demand outside transportation.

The Commerce Department earlier on Friday said new orders for U.S.-made durable goods rose 2.6 percent in February, twice forecasts, but a drop in demand outside transportation hinted at weakness in business spending plans.

New orders for durable goods excluding transportation fell 1.3 percent, well below Wall Street forecasts for a 0.9 percent rise. Transportation orders surged 13.4 percent.

In addition, orders for nondefense capital goods excluding aircraft, a proxy for business spending, dropped 2.3 percent after a scant 0.3 percent rise in January. Wall Street analysts had expected a 1.0 percent increase...

The Commerce Department revised up January orders for durable goods... Durable goods orders fell 8.9 in January rather than the 9.9 percent previously reported, the department said.

Weakness was widespread outside of civilian aircraft and defense, and inventories fell 0.5 percent in February, the largest one-month decline since November 2003.

Calculated Risk calls the new home sales number "very weak" and says the indicator "is now flashing yellow".

If the news from the US yesterday was not good, at least it was better elsewhere.

Japan's tertiary sector index of service industry activity gained 2.2 percent in January while the all-industries index rose 1.4 percent.

Meanwhile, Germany reports that its inflation rate in March slowed to 1.9 percent, the lowest level since August 2005.

Positive economic news from the US, Japan and the UK

Reuters reports a rebound in the US housing market:

The pace of home resales in the United States picked up by 5.2 percent in February, defying forecasts for a slowdown, as warm weather boosted single-family and condo sales, according to trade group data on Thursday that showed a pause in the market's cool-down.

Sales of existing U.S. homes rose to a 6.91 million unit annual rate in February, halting a string of monthly declines, after January's upwardly revised 6.57 million unit pace, the National Association of Realtors said...

But inventories also climbed 5.2 percent, leaving 3.03 million existing homes available for sale. That equates to 5.3 months' supply at the current sales pace...

The median existing home price in February was $209,000, up 10.6 percent from a year ago. That is below the larger double-digit monthly increases posted in recent years, the group's data showed. Condo price appreciation stood at 3.5 percent in February.

...as well as the labour market:

A separate report showed new claims for U.S. jobless benefits fell by a larger-than-expected 11,000 last week, suggesting a healthy labor market and more job growth in March.

The Labor Department said the number of Americans filing initial claims for state unemployment aid fell to 302,000 in the week ended March 18 from an upwardly revised 313,000 in the prior week. It was the first drop in claims after three straight weekly increases.

There was also positive news coming out of Japan in the form of a rebound in its trade balance:

Japan's trade account showed a surplus of 955.7 billion yen (US$8.5 billion) last month, 11.8 percent lower than a year ago, the finance ministry said...

Exports rose 20.8 percent to 5.85 trillion yen while imports jumped 30.2 percent to 4.90 trillion yen because of high oil import costs.

...and rising land prices in Tokyo:

Land prices in Tokyo rose in 2005 for the first time in 15 years as Japan's steady economic recovery led to strong consumer demand for condominiums and voracious demand from investors seeking commercial land, a government survey showed on Thursday...

On average, nationwide residential land prices and commercial land prices both fell 2.7 percent in 2005.

In Tokyo prefecture, residential land prices rose 0.8 percent, while commercial land prices increased 2.9 percent.

And although UK car production fell in the three months to February, manufacturing in the UK on the whole looks headed for a rebound, according to the Confederation of British Industry.

In the monthly Industrial Trends Survey, 18 per cent of manufacturers reported their order books were 'above normal' compared to 34 per cent who said they were 'below normal.'

The balance of minus 16 per cent is the most upbeat since March 2005 (-13%) and an improvement of 12 points since January.

Industrial orders fall in Europe, protectionism looms

A big drop in orders for transport equipment caused a large fall in industrial new orders in Europe, according to Eurostat yesterday.

The euro-zone industrial new orders index fell by 5.9% in January 2006 compared to December 2005 after rises of 5.3% in December and 4.9% in November. EU25 new orders decreased by 3.8% in January 2006, after increases of 5.8% in December and 3.5% in November. In both zones these changes were strongly influenced by erratic orders for heavy transport equipment: excluding ships, railway and aerospace equipment, industrial new orders grew by 0.2% in January 2006 in the euro-zone and by 2.3% in the EU25.

In January 2006 compared to January 2005, industrial new orders increased by 9.7% in the euro-zone and by 11.1% in the EU25. Total industry excluding ships, railway and aerospace equipment increased by 10.7% in the euro-zone and by 12.9% in the EU25.

The year-on-year rates still look good though, so I think there is little to worry about here.

Protectionism, on the other hand, could be a real risk.

Morgan Stanley's chief economist Stephen Roach covers the proceedings at the China Development Forum in his latest commentary. In it, he points out that China is already taking steps to "tilt its macro structure away from a growth dynamic that has become overly reliant on exports and fixed asset investment" and instead "focus increasingly on boosting its support from domestic demand -- especially private consumption".

However, the process "will take time -- and possibly a good deal of it". In the meantime, aggregate economic growth "could well slow as the consumption impetus lags the more immediate deceleration of investment and exports".

At the forum, Roach raised a question on the risks to the US-China trade relationship, to which Premier Wen Jiabao's response is described as follows:

“China views this relationship as very important,” he said, “and takes these risks very seriously.” He implied that efforts will be made to further expand Chinese imports from the US as well as deal with the all-important concerns over intellectual property rights. He was emphatic in re-emphasizing the limited role that foreign exchange policy could play in tempering the US saving shortfall and related trade imbalance -- in effect, implying no major change in the RMB exchange rate. At the end of his discourse, he leaned forward, looked me straight in the eye, and stated with great emphasis, “You can take this message back to the American people: It is unfair to make China a scapegoat for structural problems facing the US economy.”

That probably did not go down well with some US politicians. As Roach describes:

The next morning, as luck would have it, I had the opportunity over breakfast to run Premier Wen’s comment by three US politicians who just happened to be in town -- Senators Schumer, Graham, and Coburn... Schumer and Graham, of course, are co-sponsors of a bill (S. 295) that would impose 27.5% tariffs on all Chinese imports into the US unless there was an RMB currency revaluation of a like amount...

Chuck Schumer...is using the bully pulpit of a prominent politician to put so much pressure on China that it will have no choice other than to give. Nor does he have much doubt that this approach will work. “This is exactly what I did in Japan in 1986,” he said -- apparently the last time he was in Asia. “It worked in Japan and it will work in China.”

The problem is: If China after 2006 follows the path of Japan after 1986, the Chinese authorities probably would not be very pleased.

Plus they would probably have read Henry Liu.

Update: As far as protectionism is concerned, there is already criticism of the US at the WTO: From BT (subscription may be required):

THE United States came under criticism at the World Trade Organization (WTO) yesterday for pursuing what its key trading partners described as protectionist measures and unsustainable macro economic policies, diplomats said.

China said Washington is increasingly resorting to 'security exceptions' in its trade and investment policies, and that such exceptions go against an open and liberal economy.

Switzerland called on the US to adopt careful macro-economic policies to 'progressively reduce' its twin deficits.

During a US trade policy review meeting, India, Brazil, Chile, the European Union and Asean countries complained about Washington's imposition of tough restrictions on imports through the Bioterrorism Act and contingency measures such as anti-dumping and anti-subsidy regulations.

And a nationalistic trend in Europe is raising concerns there as well. From Deutsche Welle:

EU leaders will gather for their traditional two-day spring economic summit focused on promoting growth and jobs in the 25-nation bloc, which fears being overtaken by growing giants such as China and India.

But on the eve of the gathering, plans emerged for a joint letter, initiated by Italy but which may be co-signed by other more pro-reform states, denouncing a new protectionist trend in some states. EU leaders and some member countries have been dismayed at recent attempts by France and Spain to stave off takeovers by foreign companies.

US PPI down, core up, UK inflation up

The inflation data yesterday was a little mixed, but on the whole, show few signs of inflation abating.

Reuters reports that US producer prices plunged in February but core prices were up.

Plunging food and energy costs pulled U.S. producer prices down a surprisingly steep 1.4 percent in February, the biggest drop in nearly three years, but...core PPI, which strips out volatile food and energy costs, rose 0.3 percent last month after a 0.4 percent gain in January...

The 0.3 percent rise in prices outside of food and energy pushed the 12-month change in the core producer price index up to a gain of 1.7 percent from an increase of 1.5 percent in the year ended in January.

Overall producer prices have risen 3.7 percent over the past 12 months. That marked a slowdown from the 5.7 percent gain registered through January and signaled some easing in energy-led inflation pressures.

In the UK, consumer price inflation reversed a downward trend in February, according to another Reuters report.

The Office for National Statistics said consumer prices rose 0.3 percent last month, raising the annual rate a tenth of a point to 2.0 percent, hitting the Bank of England's target level for the first time since June 2005.

Inflation had appeared to be on a downward trend after peaking at 2.5 percent in September but the latest rise could mark the return of upward price pressures, particularly if recent hikes in utility bills start feeding into the March data.

This adds to doubts over future rate cuts, as do comments by Bank of England Monetary Policy Committee member Kate Barker yesterday that interest rates are "probably around a neutral level or slightly accommodative" even as she says that "the most likely outcome is for a slightly slower pace of UK growth in 2006 than the MPC's February central projection".

US leading index falls, UK GDP growth forecast and German producer price inflation rise

The US economy looks likely to slow, according to the Conference Board's leading index for the US.

The Conference Board announced today that the U.S. leading index decreased 0.2 percent, the coincident index increased 0.3 percent and the lagging index increased 0.1 percent in February...

The leading index now stands at 139.0 (1996=100). Based on revised data, this index increased 0.5 percent in January and increased 0.3 percent in December. During the six-month span through February, the leading index increased 1.5 percent, with eight out of ten components advancing (diffusion index, six-month span equals eighty percent).

No wonder Federal Reserve Chairman Ben Bernanke says that policy-makers need to tread cautiously.

On the other hand, economists are getting more optimistic on the UK economy. From Reuters:

Economists are becoming more optimistic about economic growth and less certain that the next move in interest rates will be a cut, a Reuters poll of 31 economists shows.

The median forecast in the survey, taken last week, showed the country's gross domestic product (GDP) growing 2.3 percent this year, up from a forecast of 2.1 percent in last month's poll, and above the 1.8 percent achieved in 2005.

The likelihood of an interest rate cut by the Bank of England looks even less after the recent reports of higher inflation expectations, strong growth in M4 and the continued rise in house prices in February even though mortgage lending growth slowed.

And speaking of prices, producer price inflation accelerated in Germany in February. From Bloomberg:

German producer-price inflation accelerated in February to the fastest pace in almost 24 years, led by a surge in energy costs.

Goods from plastics to newsprint were 5.9 percent more expensive in February than at the same time last year, the biggest increase since June 1982, the Federal Statistics Office in Wiesbaden said in a statement today. Economists expected a rate of 5.3 percent after 5.6 percent in January, the median of 29 estimates in a Bloomberg News survey showed. Producer prices rose 0.7 percent from a month ago.

Industrial output rebounds in the US, flattens in Europe

Reuters reports the rebound in US industrial production:

Cold weather in February boosted overall output at U.S. industrial outlets 0.7 percent, the Federal Reserve said on Friday, in line with forecasts and up from a downwardly revised 0.3 percent decline in January... Utility production rebounded 7.9 percent as weather moved closer to seasonal norms after January's balmy temperatures...

[C]apacity utilization...rose slightly less than expected to 81.2 percent. That was a return to December's capacity use rate, which was the highest since September 2000.

...and steadying consumer confidence:

The University of Michigan's confidence index held steady at 86.7 in mid-March, which was below analysts' median forecast of 88.0... Consumer expectations on inflation one year out rose to 3.2 percent from 3.0 percent in March.

On the other hand, in Europe, Eurostat reports that industrial production in both the euro zone and EU25 flattened in January -- although they were up 2.5 percent and 2.4 percent respectively when compared to January 2005 -- while growth in hourly labour costs in the fourth quarter of 2005 picked up to an annual rate of 2.4 percent in the euro zone and 2.9 percent in the EU25, up from 2.3 percent and 2.2 percent in the third quarter respectively.

Inflation tame in February

The data flow yesterday lent weight to the view that inflationary pressures may be abating.

Data yesterday showed some cooling in the US economy. As Reuters reports, they include data on inflation:

The consumer price index edged up just 0.1 percent in February as energy prices fell, the Labor Department said. But the core rate, which strips out food and energy costs, also rose just 0.1 percent...

Over the past 12 months, consumer prices have risen 3.6 percent, marking a deceleration from the energy-led 4 percent gain posted in the period through January. The 12-month change in the core CPI held steady at 2.1 percent.

...manufacturing:

[T]he Philadelphia Federal Reserve Bank said its gauge of factory activity in the U.S mid-Atlantic region fell to 12.3 in March from 15.4 in February, signaling a sharper slowing than Wall Street had expected...

The Philadelphia Fed's factory survey also offered upbeat inflation news as the measure of prices paid by manufacturers fell sharply in March to its lowest level since August 2003.

...housing:

[T]he Commerce Department said housing starts, completions and permits for future building all dropped in February...

In its report, the Commerce Department said housing starts dropped 7.9 percent in February to a 2.120 million unit annual pace from an upwardly revised 2.303 million unit in January.

The drop, however, followed a big jump in January due to warm weather and was not as sharp as economists had expected.

...and the labour market:

[N]ew claims for U.S. jobless benefits unexpectedly edged up by 5,000 last week to 309,000, the highest level of the year.

This pushed a four-week moving average of claims, which offers a better view of underlying trends, up by 2,750 to 296,500. While the average is at its highest since mid-January, it still suggests a robust labor market.

There is also little evidence of accelerating inflation in Europe. The annual inflation rate for February was 2.3 percent for the euro zone, down from 2.4 percent in January, and 2.2 percent in the EU25, unchanged from January. Inflation excluding energy, food, alcohol and tobacco in the euro zone was unchanged in February from the previous month at 1.2 percent.

In China, the corporate goods price index rose 0.5 percent in February over the previous month, but the year-on-year increase was only 0.7 percent. This despite an investment climate that still remains hot. From AFP/CNA:

China's fixed asset investment expanded at a brisker pace in the first two months of the year, official figures show, belying government efforts to peg growth at a more sustainable pace.

Capital spending on plant, roads and power grids in urban areas rose 26.6 percent year-on-year in January and February, the National Bureau of Statistics said.

In the UK, there was more evidence of re-accelerating house prices from the Royal Institution of Chartered Surveyors while February retail sales showed some recovery from a dismal January.

Economic news mixed, fund managers get defensive

On the whole, yesterday's news from the US appear to have gone down better with the stock market than with the fixed income market. Reuters reports:

Stocks rallied to nearly five-year highs... The Dow Jones industrial average gained 58.43 points, or 0.52 percent, to 11,209.77. U.S. Treasury debt prices finished lower.

The inflation picture was mixed.

[I]mport prices fell 0.5 percent in February, as expected, as the cost of imported petroleum, natural gas and food declined. The drop in import prices was the first since November and followed an upwardly revised 1.4 percent rise in prices in January...

The Fed's Beige Book survey of regional economic conditions, prepared for the upcoming policy meeting, said businesses reported input cost pressures in January and February. Elevated energy costs were frequently mentioned.

However, retail prices increased at only a moderate rate, the report said, and labor cost pressures were little changed, with most districts saying wages increased modestly.

Manufacturing activity remains strong.

The New York Fed said its "Empire State" index of manufacturing conditions surged to 31.16 in March, its highest level since July 2004, from 21.02 in February.

But foreigners appear reluctant to step up the pace of purchase of US debt.

Another set of data on Wednesday showed that net capital inflows to U.S. assets in January totaled $66 billion, the second straight month that inflows were not enough to offset the month's trade deficit.

The Treasury Department said net foreign purchases of U.S. Treasury bonds and notes slowed sharply, to $4.4 billion, far below forecasts of $18.1 billion.

There was also mixed news on the UK economy, with unemployment last month rising at its fastest rate since the 1992 recession and average earnings in January growing less than expected, but the Conference Board's leading index for the UK increasing 0.2 percent in January.

The news from Asia yesterday provides more evidence of how strong economic growth has been, with exports helping China's industrial output from state-owned and large non-state enterprises rise 16.2 percent in the first two months of 2006 compared with a year earlier, and Singapore's unemployment rate dropping to 2.5 percent in December -- the lowest level in more than four years -- on the back of the strongest annual employment growth in eight years.

In fact, perhaps growth is getting too hot -- see "TSMC’s Capacity for Q2 Fully Loaded With Excessive Orders" for example.

Some investors apparently think so. Merrill Lynch's March survey of global fund managers found that a growing number of survey respondents believe the global economy is now operating "above-trend" and expect core inflation to rise. With the global economy on balance not expected to get stronger, fund managers are getting more defensive, raising cash levels, shortening investment time horizons and reducing exposure to emerging markets.

And perhaps the expansion in the global market for credit derivatives is also a concern.

Equities rising, emerging markets drawing record funds

Stocks in the US rose yesterday. From Reuters:

U.S. stocks rose sharply on Tuesday, driving the Dow and S&P 500 indexes to their highest levels in nearly five years as U.S. bond yields fell and Goldman Sachs Group Inc. reported record profit.

The biggest one-day decline in U.S. Treasury 10-year note yields in six months, following an unexpectedly large drop in February retail sales, helped ease interest-rate worries for stock investors who fear that higher rates will hurt corporate profits.

However, for 2006 so far, emerging stock markets have been the biggest winners, as The Capital Spectator shows. European Emerging, in particular, has risen 17.3 percent through 13 March on a total US-dollar-return basis.

Record inflows of funds have helped emerging markets, as Bloomberg reports:

Emerging-market equity funds have attracted $20.9 billion this year, eclipsing the record inflows they garnered in all of 2005, as faster economic growth and a commodities boom lured investors to markets from India to Russia.

It is tempting to see all this as a euphoric top, but this can obviously go on for a long time if central banks keep pumping liquidity. While the world's three major central banks are now in tightening mode, they are all doing so at a very measured pace.

Falls in US retail sales and current account larger than expected

The economic news from the US yesterday was not particularly good. Reuters reports the fall in retail sales:

Retail sales fell a larger-than-expected 1.3 percent last month, the first decline since August and sharper than the 0.8 percent decline forecast by Wall Street.

But the Commerce Department revised up January sales to a 2.9 percent rise, the largest increase in more than four years, from 2.3 percent originally reported, and analysts shrugged off February's weakness as an inevitable pullback after warm weather boosted shopping in January...

The retail sales report showed demand outside the auto sector was down 0.4 percent in February, in line with analyst expectations, in the largest decline since April 2004.

...the rise in the current account deficit:

A separate report showed the U.S. current account deficit, the broadest measure of U.S. trade with the world, widened in the fourth quarter to a $224.9 billion as imports of goods jumped and net unilateral current transfers rose sharply.

The quarterly shortfall in the current account was much larger than Wall Street forecasts for a gap of $217.7 billion and pushed the 2005 deficit to a record $804.9 billion, or 6.4 percent of gross domestic product, from 5.7 percent of GDP in 2004.

...and the rise in business inventories:

A third report from the Commerce Department showed business inventories rose 0.4 in January, slightly above Wall Street forecasts for a 0.3 percent gain, while business sales climbed 1.3 percent. That pushed the inventories-to-sales ratio, a measure of how long it would take to deplete stocks at the current sales pace, to a record low 1.24 months.

Among bloggers covering the news, Mark Thoma compares the retail sales against long-term trends, Brad Setser forecasts a 2006 current account deficit of about $950 billion, while just about everyone ignores the news on business inventories.

Those hoping to see a reduction in the US current account deficit can expect little help from any revaluation of the renminbi after China's prime minister Wen Jiabao said that it is "no longer necessary for us to take one-off administrative means to affect the fluctuation of the RMB exchange rate either upwards or downwards".

Meanwhile, Japan's economic recovery appears to remain on track. From AFP/CNA:

Japanese plants and factories boosted output by 0.4 percent in January, more than previously thought, taking industrial output up to new record high levels, the government said... Industrial output was up 2.2 percent in January from a year earlier, figures from the Ministry of Economy, Trade and Industry showed...

January's performance marks a slowdown from December's 1.3 percent month-on-month growth and year-on-year expansion of 3.7 percent.

Sentiment in Europe appears to be moderating, according to the ZEW.

The ZEW Indicator of Economic Sentiment for Germany dropped by -6.4 points in March. Compared with +69.8 points in February, the indicator’s current level of +63.4 points is far above its historical average of + 35.1 points...

Economic expectations for the euro zone have slightly decreased in March. The indicator now stands at +61.1 points versus +66.0 points in February.

Yellen warns of overshooting by Fed, UK prices continue to rise

Janet Yellen, President of the San Francisco Federal Reserve, had this to say to reporters after her speech to the National Association for Business Economics: "I think we're in a range where Fed decisions have become quite data-dependent and there does need to be sensitivity to the possibility of overshooting."

Not too hawkish there. For her conference speech itself, see this Reuters report.

Overshooting would be bad for economic growth, but a premature end to tightening would leave inflation untamed, which may be what we are seeing in the UK, where inflation has proven surprisingly persistent, especially in house prices:

UK house prices are accelerating, according to figures from the Office of the Deputy Prime Minister (ODPM).

Its latest monthly survey of new mortgage loans shows that prices rose by 4.3% in the year to January.

That was higher than the 2.9% rate recorded in December and is the highest since the middle of last year.

However, UK producer prices held steady in February:

The Office for National Statistics said on Monday that output price inflation held steady at an annual rate of 2.9 percent even though manufacturers' raw material costs did not rise last month for the first time in five months.

Falls in Japan's current account surplus and China's trade surplus

It is not too often that you see falls in both Japan and China's trade balances.

AFP/CNA reports Japan's current account for January:

The surplus in the current account, the broadest measure of trade in goods and services, declined 7.6 percent in January from a year earlier to 719.1 billion yen (6.05 billion dollars), the finance ministry said...

The trade account alone registered a deficit of 209.4 billion yen in January, compared to a surplus of 332.3 billion yen a year earlier...

Exports rose 13.1 percent to 4.76 trillion yen in January, up for a 26th straight month, while imports jumped 28.1 percent to 4.97 trillion yen, the 23rd consecutive monthly increase.

Bloomberg reports China's trade balance for February:

The surplus fell to $2.45 billion from $9.49 billion in January, the customs bureau said today on its Web site. That was below the median $7.5 billion forecast in a Bloomberg News survey of economists. Imports jumped 30 percent as higher oil prices boosted the value of overseas purchases...

Exports rose 22 percent after jumping 28 percent in January. Sales may have slowed because some businesses rushed to fill orders ahead of the Lunar New Year holiday, which fell in January this year and in February in 2005, Hui said.

In other news on these two economies, Japan's fourth quarter GDP was revised down slightly to 1.3 percent or 5.4 percent in annualised terms, Japan's consumer confidence index edged up in February, China's actual foreign direct investment for the January-February period rose 7.79 pct year-on-year, and China's consumer inflation rate slowed to 0.9 percent year-on-year in February.

US economy adds 243,000 job in February

Yesterday's US jobs report was slightly better than expected. Reuters reports:

U.S. employers added a stronger-than-forecast 243,000 jobs in February but the unemployment rate edged up, the Labor Department said on Friday...

Average hourly earnings grew 0.3 percent during February, in line with expectations, but in the 12 months through February pay rose by 3.5 percent, which department officials said was the highest annual increase since September 2001.

The February job gain followed a revised 170,000 new jobs in January that was originally reported as 193,000...

The average workweek in February was 33.7 hours, down from 33.8 hours in January.

Yesterday also saw the Federal Statistical Office in Germany release February consumer prices -- up 0.4 percent over January and 2.1 percent over February 2005 -- February wholesale prices -- up 0.5 percent over January and 2.9 percent over February 2005 -- and January trade data -- exports up 3.3 percent over December and 13.3 percent over January 2005, imports up 3.0 percent and 18.7 percent respectively.

While these data point to a global economy that is still hot, one day after the Bank of Japan eased up on its easy money policy, the news from Japan was looking somewhat cooler, with private machinery orders excluding shipping and utilities falling a seasonally-adjusted 6.2 percent in January and household spending falling a seasonally-adjusted 1.9 percent.

And in China, producer price inflation continued to trend down in February. From Shanghai Daily:

The producer price index climbed 3 percent in February compared with the same month last year, the National Bureau of Statistics said yesterday. That was the smallest growth rate since January 2004.

BOJ ends ultra-loose policy, US trade deficit hits record

The Bank of Japan's decision yesterday could potentially be a momentous one, although we probably will not know for sure for a while. Reuters reports:

The Bank of Japan scrapped a five-year-old experiment with ultra-loose monetary policy on Thursday and returned to a more conventional regime, but said it would still keep short-term interest rates around zero for now.

Recent strong economic data from Japan, including a rise in the leading index to 85.0 in January from a 75.0 in December, sealed the move.

Another important news yesterday was the record US trade deficit. Again from Reuters:

The U.S. trade deficit swelled to a record $68.5 billion in January, as the world's largest economy's ravenous appetite for foreign goods hit new heights and overpowered record exports, a government report showed on Thursday.

The monthly trade gap widened 5.3 percent from a revised estimate of $65.1 billion in December and surprised Wall Street analysts who had forecast less of a surge...

U.S. imports rose 3.5 percent in January to a new high of $182.9 billion... High prices for imported oil, which increased more than 4 percent in January to an average of $51.93 per barrel, helped push the trade gap to a new high... Many analysts, however, focused on the trade gap for non-petroleum goods, which posted a record $49.6 billion...

In a sign of improved economic growth overseas, U.S. exports increased in January to a record $114.4 billion, up 2.5 percent from the previous month...

In contrast, the UK's trade deficit narrowed in January. From AFX/Forbes

The office for National Statistics revealed that the trade in goods deficit in January narrowed to 5.73 bln stg from 6.1 bln stg the previous month. The latest figure is the narrowest since October when a deficit of 5.1 bln stg was recorded...

Total exports in Jan rose 0.6 pct from the previous month to 18.8 bln stg while imports slipped 1.1 pct to 24.5 bln stg.

Also in the UK, the Bank of England left interest rates unchanged yesterday. From Reuters:

The Bank of England kept interest rates at 4.5 percent for the seventh month running on Thursday and expectations of a cut in borrowing costs this year are waning...

News...of rising house prices, the services economy expanding at the strongest pace in nearly two years and even manufacturing output rising three months running has raised doubts about whether the economy needs a monetary boost.

House prices jumped by 1.4 percent in February, their biggest gain in six months, according to the Halifax survey, while industrial output rose by 0.4 percent in January and manufacturing output rose by 0.2 percent.

On a negative note, German industrial production fell 0.1 percent in January, led by a drop in construction amid unusually cold weather. Manufacturing output, however, rose 1.3 percent in January, while December industrial output was revised to a 0.7 percent increase from an initially-reported 0.5 percent decline.

US resource utilisation: Lower over the long term, slower over the short term

Even as markets push interest rates higher over the past few weeks in the face of data showing that the US and global economies remain robust and central banks' apparent willingness to raise official rates higher, not everyone is convinced that the strength of the economy is sustainable or that it warrants higher interest rates.

In her Bloomberg article on 3 March, Caroline Baum wrote that the US economy looks headed for a slowdown. Consumer spending has slowed on a year-over-year basis while debt burdens are rising, with debt payments as a share of disposable income having risen to an all-time high of almost 14 percent in the third quarter. As for investment, she pointed out that with growth slowing, companies are not likely to get aggressive about investing while residential investment is showing signs of deceleration.

In another article on 7 March, Baum looked at the US labour market for evidence of tightness and she found little.

First she dismissed tightness in industry capacity utilisation. "When Fed policy makers talk about resource utilization in today's produce-it-where-it's-cheapest world, they aren't talking about the industry operating rate, which stood at 80.9 percent in January, a touch below the 33-year average," she wrote.

She acknowledged the improvement in the unemployment rate, "which dipped to a 4 1/2-year low of 4.7 percent in January, down from a cycle peak of 6.3 percent in June 2003", but then dismissed the significance of the fall by pointing out that "the U.S. economy experienced high unemployment and inflation simultaneously in the 1970s and low unemployment and inflation in the 1980s". In any case, she pointed out that the "percentage of the population that is in the labor force (employed or unemployed) has been drifting lower since its peak in the first quarter of 2000 (66.9 percent)".

Turning to the average workweek, she wrote: "The average workweek has been flatlining for 3 1/2 years at 33.6 to 33.8 hours. That's well below the average of 34.3 hours in the 1990s, 34.8 hours in the 1980s and 36.3 hours in the 1970s -- all decades that had their share of workweek-depressing recessions."

As for wages, she pointed out that average hourly earnings have risen, but at a pace barely ahead of inflation. "Labor's share of the income pie was 57.4 percent last year, up from 56.7 percent at the 1997 trough but well below the 1980 peak (61.1 percent)," she wrote.

She concluded: "Unless the adverse effects of the tight labor market surface soon, policy makers may have to find another justification for raising rates."

However, while what Baum says is essentially correct, in her attempt to link the labour market to monetary policy, it would probably be useful to distinguish between long-term and short-term trends.

Baum's 7 March article highlights a long-term trend of lower resource utilisation (the article alludes to globalisation as a factor behind this trend, at least for industry capacity). While Baum seems to be saying that the low utilisation rates suggest that interest rates should not be raised any further, it is worth remembering that this long-term trend is not the result of higher interest rates -- indeed interest rates are also at historically low levels.

So keeping rates at current low levels would not address the underlying factors behind this trend. In fact, it could potentially aggravate the debt problem that she cites in her 3 March article as a reason why consumer spending may slow.

If long-term trends suggest some degree of inevitability in lower resource utilisation -- at least with respect to interest rates -- do short-term or cyclical trends indicate any short-term overheating in the economy that warrants further interest rate hikes?


The chart above shows that the year-on-year change in industrial capacity utilisation is at the upper end of its historical range, but already slowing from its peak in 2004. Similarly, the year-on-year change in average weekly hours appears to have already peaked. These observations arguably add more substance to the view that the Federal Reserve should stop its hiking campaign -- or at least be close to stopping -- if its wants to avoid a recession.

More likely, though, most who think that the Federal Reserve should halt would base their opinion on the inverted yield curve -- 2-year Treasuries now yield more than 10-year Treasuries. If that does not stop the Federal Reserve from further rate hikes, squiggles like those on the above chart are not likely to either.

Canada raises interest rates, Australia holds

Yesterday, the Bank of Canada raised interest rates. From Bloomberg:

The Bank of Canada raised its main interest rate for the fifth straight time and changed its language to say another increase was less certain, causing the currency to fall by the most in two months.

The quarter-point increase today brings the target rate for overnight loans between commercial banks to 3.75 percent, the highest since September 2001, and narrows the gap with the 4.5 percent U.S. federal funds rate. All 34 economists polled by Bloomberg News predicted the move.

However, today, the Reserve Bank of Australia decided not to change rates. Again from Bloomberg:

Australia's central bank left interest rates unchanged for a 12th month after growth in Asia-Pacific's fifth-largest economy slowed and home-building approvals fell to a five-year low.

Central bank Governor Ian Macfarlane and his board kept the overnight cash rate target at 5.5 percent today, as forecast by all 22 economists surveyed by Bloomberg News. The bank last raised rates in March 2005. Macfarlane in February said rates were more likely to increase than fall, though he didn't plan a move anytime soon.

And the Bank of England also looks unlikely to change rates tomorrow, according to this Reuters report:

Interest rates will almost certainly stay at 4.5 percent this week and economists are no longer so sure the Bank of England will cut borrowing costs again in the next few months.

All 40 analysts polled by Reuters last week predicted the central bank's Monetary Policy Committee would keep rates steady for the seventh month this Thursday. Many said slow economic growth will prompt another cut as soon as May.

But more news showing the economy picking up speed and house prices once again rising has got people thinking that the next rate move may well be up, even if not for some time.

News such as this from Reuters:

Retail sales rose on an annual basis for a fourth straight month in February, a report showed on Tuesday, suggesting that consumer spending continued to hold up after the key Christmas holiday period.

The British Retail Consortium said that like-for-like sales climbed 0.6 percent in February on a year earlier after a meagre 0.2 percent annual gain in January.

Total sales, which include all floorspace, rose 3.5 percent, slightly ahead of January's 3.4 percent gain. The three-month rate for total sales also picked up to 4.2 percent from 3.6 percent, which the BRC said reflected growing floorspace.

Japan is certainly not raising rates tomorrow, but an end to quantitative easing is expected by many, and the latest report on bank lending will likely be pertinent to the Bank of Japan's decision.

Japan's bank lending rose for the first time in more than nine years, signaling an expansion of credit that may help the world's second-largest economy grow.

Bank lending rose 0.2 percent in February from the same month a year earlier, a central bank report in Tokyo today showed. Lending adjusted for factors including currency fluctuations, securitizations and bad loan write-offs rose 1.4 percent, the seventh monthly gain.

The European Central Bank had made its decision to raise interest rates last week (see earlier post). Excess liquidity apparently was a major factor, according to this Reuters report:

Three factors appear to have persuaded even the more reluctant ECB policymakers that they must redouble their efforts to keep that monster bottled -- inflation dangers, improving economic growth and masses of cheap money. The latter seems to have clinched the case for higher ECB interest rates.

Analysts said these factors -- coupled with a lack of dissenting voices on the ECB Governing Council -- have persuaded financial markets in recent days that the ECB is heading faster than previously expected toward an official interest rate of 3 percent, or even 3.25 percent by the year-end.

Data on German factory orders in January at least supports the notion that the economy is improving.

Orders rose 1.4 percent from December, when they fell a revised 0.3 percent, the Economy and Technology Ministry in Berlin said in a faxed statement today. Economists predicted a 1.3 percent increase, the median of 42 forecasts in a Bloomberg News survey showed. From a year earlier, orders rose 14.3 percent, the most since March 2004.

There is no interest rate decision in the US this week, but the upwardly revised fourth quarter productivity data released yesterday -- and reported by Reuters -- will no doubt be taken into consideration in the Federal Reserve's decision at the next FOMC meeting.

Worker output per hour fell at a 0.5 percent annual rate in the final three months of 2005, the first drop in nearly five years, the Labor Department said. That was a slight improvement from the 0.6 percent drop reported a month ago...

Unit labor costs -- a key gauge of profit and price pressure -- rose at a 3.3 percent annual rate in the fourth quarter, the report showed. That was down from an initially reported 3.5 percent rise...

Separate reports showed mixed results at U.S. chain stores last week.

Sales ticked up 0.2 percent last week after rising 1.5 percent in the prior week, and were up 4.3 percent compared with the same week a year earlier, according to a report produced by the International Council of Shopping Centers and UBS Securities LLC.

But independent company Redbook Research said sales at major retailers so far in March were down 2.5 percent when compared with the same period in February. Sales were up 2.4 percent last week compared with the same week a year ago.

And consumer credit data from the Federal Reserve, reported by Reuters:

U.S. consumer credit rose by a less-than-expected $3.94 billion in January as car and boat loans slowed, a Federal Reserve report showed on Tuesday...

Consumer credit outstanding rose to $2.162 trillion in January, rising at an annual rate of 2.2 percent from the revised $2.158 trillion in December.

US factory orders, pending home sales fall in January

Yesterday's news on the US economy was negative but still better than expected. Reuters reports:

Factory orders fell 4.5 percent in January, slightly less than expected but still the biggest drop since July 2000, as orders for durables, machinery, computers, and aircraft fell, a Commerce Department report showed.

Analysts polled by Reuters were expecting factory orders to fall 5.3 percent.

Orders for durable goods...fell 9.9 percent, the steepest decline since a 14.2 percent drop in July 2000. However, the decline in durables was revised up from a 10.2 percent drop reported February 24...

Factory orders for December were revised up to a 1.6 percent rise from an initially reported 1.1 percent gain...

Non-defense capital goods excluding aircraft, a proxy for business spending, rose 0.1 percent...

The Pending Home Sales Index, based on contracts signed in January, stood at 116.3, down 1.1 percent from December and 4.8 percent below a year ago, the National Association of Realtors said. December's index was revised up to 117.6 from an originally reported 116.4.

In its latest assessment of the economic outlook, the OECD expects a rebound in the US economy in the first quarter.

The marked economic slowdown in the United States in the fourth quarter of 2005 reflected the adverse one-off effects of the late summer hurricanes rather than fading underlying strength... Recent US data point to a sharp rebound in the first quarter of this year, even after taking into account that unseasonally mild weather in January boosted retail sales and some of the other high-frequency indicators. Job creation has remained robust and business confidence is consistent with above-par growth in the near term.

For the other G7 economies:

In Canada...growth has remained resilient... Japan is now enjoying a broadbased recovery... [T]he strong external side should feed through to euro area domestic demand and a rebound can be expected in the first half of 2006... In the United Kingdom, activity is set to continue to grow at around its potential rate.

Investor sentiment turns down but not the economy

With the global equity bull market now around three or more years old, many investors are getting nervous about a possible turn in the market. However, economic indicators around the world provide few hints that the global economy is about to turn down any time soon.

Investor sentiment appears to have turned down of late. For example, Merrill Lynch's survey of global fund managers in February found them more cautious than in January, with cash levels rising to 4.1 percent from 3.5 percent in January and perception of recession risk rising. And according to Investors Intelligence's sentiment survey, the bull/bear ratio among investment advisors fell to 1.38 last week, close to the bottom end of its range over the past three years.

Of course, some contrarians would interpret this weakness as a bullish indication: Extremely weak sentiment on stocks is often a prelude to a reversal in sentiment that could drive stock prices higher.

Nevertheless, one should not ignore the fact that there is some basis for bearishness. Some bears have pointed to recent negative data in the economic indicators. For example, fourth quarter GDP growth in the United States was an anaemic 1.6 percent, new orders for US-made durable goods plunged 10.2 percent in January -- mainly due to a fall in non-defence aircraft orders -- homes sales in the US were also down in January, while consumer sentiment deteriorated in February.

Even in resurgent Japan, there have been blips in the stream of economic news, the most recent coming last Friday with the government reporting that the unemployment rate rose to 4.5 percent in January from 4.4 percent in December and salaried household spending in January fell by 4.7 percent from a year earlier and by 1.5 percent from the previous month.

And yet, analysts making a bear case by pointing to a weakening economy have a difficult task making it sound convincing because in reality, positive economic news have continued to predominate in recent weeks, especially on a global basis.

For example, indices derived from surveys of supply managers in most major economies were above 50 and rising for both manufacturing and services, implying accelerating economic growth. The All-Industry Output Index for February -- produced by JP Morgan together with research and supply organisations and combining service sector and manufacturing data from countries including the United States, the euro zone, Britain, Japan and China -- rose to 58.3 in February from 56.6 the previous month.

Other economic indicators reported have also been positive. The Conference Board's index of leading US economic indicators jumped 1.1 percent in February while sentiment surveys in Europe generally revealed optimism, with the Ifo index on German business confidence for example rising to a 14-year high of 103.3 in February from 101.8 in January.

Asset prices have continued to hold up, including those of homes in the US despite slowing sales. And this has probably helped prop up the main driver of global economic growth -- US personal spending rose 0.9 percent in January, even faster than a 0.7 percent rise in personal income.

However, these gains are increasingly being undercut by inflation. Although core US consumer prices -- excluding food and energy -- continued to rise moderately by 0.2 percent in January, overall consumer prices actually surged by 0.7 percent in January, bringing the rise over the past year to 4 percent, up from 3.4 percent in December.

It is a similar story in the euro zone, where the annual rate accelerated from 2.2 percent in December to 2.4 percent in January. Even in deflation-ridden Japan, core consumer prices excluding fresh food increased 0.5 percent from a year earlier in January and 0.1 percent if both energy and food are excluded.

Therein lies the real immediate risk to equities: higher inflation and interest rates. Indeed, last week, the European Central Bank raised interest rates by 25 basis points and gave indications of possibly more hikes to come, while Japan, finally out of deflation, is expected by many to end its ultra-loose monetary policy soon, possibly as early as this week.

The implications are not lost on fixed income markets, even in the US, where long-term yields had stayed stubbornly low in the past year or two in the face of Federal Reserve rate hikes. On Friday, the yield on the 10-year Treasury was 4.68 percent, up 11 basis points over the week.

And the implication of that on the stock market should not be lost on investors either. Stock markets usually do not like rising interest rates. In fact, stock markets often rise -- seemingly perversely -- in the face of weak economic data precisely because of the prospects for lower interest rates. Persistently low interest rates in the past few years have almost certainly been an important factor in sustaining the bull run in stock markets so far. However, with the global economy as strong as it has been, the global interest rate environment has been changing -- and looks set to change further -- in the tightening direction.

So the bears may yet have a case, but one that is made out of the strong economic data, not the weak ones.

ECB raises interest rates amid strong economic data

The European Central Bank raised interest rates yesterday in a move that surprised practically no one. From Bloomberg:

"We stand ready to do whatever is necessary and appropriate to ensure price stability," ECB President Jean- Claude Trichet said at a press conference in Frankfurt after the ECB lifted the refinancing rate to 2.5 percent from 2.25 percent. The ECB has "a stimulative monetary policy. There is no doubt in my mind."

And yesterday's data from Europe, including those from Germany, would not have inspired any doubt:

German retail sales rose the most in more than a year in January and orders for plant and machinery surged, adding to evidence that growth in Europe's largest economy is gathering pace.

Sales, adjusted for inflation and seasonal swings, climbed 2.7 percent from a month earlier, the biggest gain since June 2004, the Federal Statistics Office in Wiesbaden said today. Domestic orders jumped 27 percent in January from a year earlier, according to the VDMA industry association.

And European producer prices surged in January:

The euro-zone industrial producer price index rose by 1.2% in January 2006 compared with the previous month. In January 2006, EU25 prices rose by 1.1%. In December 2005 prices increased by 0.2% in the euro-zone and by 0.6% in the EU25.

In January 2006 compared to January 2005, industrial producer prices rose by 5.3% in the euro-zone and by 7.1% in the EU25.

As usual, energy was the main reason for the jump in prices, but even excluding energy, prices increased by 0.4 percent in both the euro-zone and the EU25.

In the US, the news was somewhat mixed. The labour market remains relatively robust, according to Reuters:

Initial filings for state unemployment insurance aid rose to 294,000 in the week ended February 25 from an upwardly revised 279,000 for the previous week, the Labor Department said... A department analyst said the rise in new claims was due in part to a failure of the seasonal adjustment process to anticipate two holidays not celebrated nationwide -- Abraham Lincoln's birthday and Presidents' Day.

A separate report by the outplacement firm Challenger, Gray and Christmas showed the number of corporate layoffs in the pipeline fell 15.5 percent in February to their lowest level in four months, with fewer job cuts in telecommunications, consumer products, manufacturing and industrial goods industries.

But there are more doubts in retail:

In preliminary figures for February, America's largest retailers said cold weather and a major winter storm hurt sales and warned a later Easter holiday would hurt March results.

Strong US consumer spending and global manufacturing

On the whole, the economic data are still coming in strong, especially in manufacturing.

Reuters reports the news on US personal income and expenditure:

January was one of the warmest months on record, luring consumers into stores and producing a 0.9 percent jump in spending that outpaced a 0.7 percent rise in personal incomes... Americans' savings rate...eased to -0.7 percent from -0.4 percent...

The Commerce Department's price index for consumer spending rose 0.5 percent in January after being unchanged in December. The core index, which strips out food and energy, rose a milder 0.2 percent, in line with forecasts and up slightly from a 0.1 percent increase a month earlier.

...car sales:

Yet car sales data trickling in from automakers suggested the early year spending spree was not repeated in February. Sales of North American-made vehicles were tracking just below forecasts of around 13.3 million annualized units, still robust but down from more than 14 million the previous month.

...and manufacturing:

[T]he Institute for Supply Management's index of national factory activity rose to 56.7 in February from 54.8 in January, beating economists' forecasts for a rise to 55.6. The factory figures also showed broad underlying strength, with employment and new orders both showing healthy spikes.

PMI data for February were also good elsewhere. The euro-zone PMI rose to 54.5, the highest since July 2004, from 53.5 in January. The UK PMI slipped to 51.7 from 51.8 in January, but the China PMI rose to a record 50.7 from 50.2 the previous month. The JPMorgan Global Manufacturing PMI rose from 54.4 in January to 55.3 in February, its highest level in one-and-a-half years.

Economic data weak in US and UK, better elsewhere in Europe and Asia

Reuters rounds up the news on the US economy yesterday, including that on fourth quarter GDP:

The U.S. economy grew at an upwardly revised but still-weak 1.6 percent annual rate in the fourth quarter... The revised fourth-quarter data on U.S. gross domestic product reflected a faster pace of capital spending by government and business, and a bigger build up of inventories than initially estimated... Growth for all of 2005, however, was unrevised at 3.5 percent...

Inflation indices were little changed. A core price measure that strips out food and energy costs increased at a 2.1 percent rate, down from the 2.2 percent pace reported a month ago.

... existing home sales:

Sales of existing homes fell 2.8 percent last month to a 6.56 million unit annual rate, the National Association of Realtors said. At that pace, the inventory of unsold homes marked a 5.3 months' supply, the highest since August 1998...

Home prices, however, have been more resilient. The median price for an existing home rose 11.6 percent in January to $211,000.

... consumer confidence:

In a separate report, the private-sector Conference Board said its index of consumer sentiment fell in February to 101.7 from 106.8 in January as feelings on the future soured.

... and Midwest manufacturing activity:

The National Association of Purchasing Management-Chicago business barometer fell to 54.9 in February from 58.5 in January.

Markets appear to view the data as negative for the US economy, with US stocks falling and US treasuries rising yesterday.

There was more negative news from the UK where, contradicting other reports (for example, see yesterday's post), the Nationwide building society reported that house prices fell 0.2 percent in February. February also saw falls in UK consumer confidence and retail sales volume.

It was generally better elsewhere in Europe though, as the FT reports.

Inflation excluding energy, food, alcohol and tobacco...fell from 1.4 per cent in December to 1.2 per cent last month – the lowest since February 2001. The “core” inflation figures compared with a headline inflation rate of 2.4 per cent in January, up from 2.2 per cent in December.

... France’s unemployment rate in January nudged higher, and Germany saw a much smaller-than-expected fall of 5,000 in its seasonally adjusted unemployment total to 4.695m in February.

But the Commission’s survey showed manufacturing and service companies have become more optimistic about their employment expectations. The Commission’s eurozone “economic sentiment” index rose from 101.5 in January to 102.7 in February, the highest since June 2001. Economic sentiment improved in Germany, where industrial confidence has soared in recent months, and in France.

News from Asia yesterday was also strong. From Finfacts:

South Korea's industrial production gained 6.1 percent in January, the most in more than seven years...

Japan's industrial production rose for a sixth month, the longest period of expansion in nine years... Production rose a seasonally adjusted 0.3 percent in January from December to a record...

In Japan also, the Nomura/JMMA Purchasing Managers’ Index PMI...remained unchanged at 57.0 in February, signalling an improvement in manufacturing business conditions for the thirty-third consecutive month and a rate of expansion identical to the survey record high seen in January.

But the news from Australia today was less positive. From Bloomberg

Australia's economy grew less than expected in the fourth quarter as home building fell and consumer spending slowed, tempering increased investment by companies. Gross domestic product gained 0.5 percent from the third quarter, when it rose a revised 0.3 percent, the Australian Bureau of Statistics said today.