Stocks surge as Fed talks of cooling in the US while data show heating in Europe

It was a pretty good day for stocks yesterday.

	28 June close	29 June close	Percent change
S&P 500	1,246.00	1,272.87	2.2
Nikkei 225	14,886.11	15,121.15	1.6
FTSE 100	5,678.6	5,791.5	2.0
DAX	5,456.87	5,581.67	2.3
CAC 40	4,774.00	4,880.38	2.2
Hang Seng	15,742.66	15,880.46	0.9
Straits Times	2,350.80	2,386.77	1.5

The Federal Reserve raised interest rates yesterday, but its accompanying statement was seen to be dovish enough to propel the S&P 500 to its biggest one-day percentage gain since October 2003. Reuters has a wrap-up of all the main news from the US yesterday.

The U.S. economy grew at a revised 5.6 percent annual rate in the first quarter, as the fastest pace of growth in 2-1/2 years generated robust corporate profits, the Commerce Department said on Thursday...

On Thursday, the Federal Reserve announced it was raising its trendsetting federal funds rate another quarter percentage point to 5.25 percent -- a 17th straight hike -- but noted recent signs that "economic growth is moderating."

Fed policy-makers said that, while some inflation risks remain, slower growth should ease inflation pressures, raising hopes its prolonged rate-rising campaign was near an end...

Separately, the Labor Department reported that new claims for new weekly jobless pay climbed by 4,000 last week to 313,000 -- still a level that analysts say is consistent with a healthy job market.

The four-week moving average of new claims, which smoothes weekly volatility to offer a better picture of underlying labor market trends, fell by 6,000 last week to 305,500.

Mark Thoma has a detailed analysis of the FOMC statement at Economist's View.

Even as the Fed talks about slower growth in the US, Japan actually saw industrial output fall in May.

Industrial production declined by a bigger than expected 1.0 percent in May compared with April but was up 4.2 percent year-on-year, the trade ministry said in a preliminary estimate...

The ministry, however, forecasts a recovery in June and July, saying: "Industrial production is on a moderately upward trend."

Meanwhile, European economies still look relatively hot, as Bloomberg reports.

Germany's seasonally adjusted jobless rate fell to 10.9 percent in June, the lowest since 2004, from 11 percent in May, the Federal Labor Agency in Nuremberg said today. M3, the ECB's preferred measure of money supply, rose 8.9 percent in May from a year earlier, after gaining 8.7 percent in April. The Frankfurt- based bank says more than 4.5 percent risks stoking inflation.

And it is a similar picture in the UK, reports Reuters.

Outstanding mortgage debt hit a seasonally adjusted 1,006,796 million pounds in May as net lending surged by 9.304 billion pounds, the biggest monthly gain for 2-1/2 years...

The number of mortgage approvals rebounded to 117,000 in May from 106,000 in April, suggesting that housing market activity will stay strong in coming months...

House price data also out on Thursday showed a 0.3 percent rise in June taking the annual rate of increase to 5.0 percent, its highest in three months, according to the Nationwide Building Society...

Thursday's figures also showed consumer credit shot up in May by 1.225 billion pounds in May compared with 816 million pounds in April and against forecasts for an increase of 1.0 billion pounds.

Total net lending showed its strongest gain in nearly two years at 10.529 billion pounds, up from 9.368 billion in April.

Retail sales up, but for how much longer?

Retail sales rose in Japan in May, and the World Cup apparently has something to do with it. Bloomberg reports:

Retail sales, which reflect sales at brick-and-mortar businesses including department stores and supermarkets, rose 0.1 percent in May from a year earlier, the trade ministry said in Tokyo. The median forecast of 21 economists surveyed by Bloomberg News was for sales to drop 0.6 percent...

Fuel sales surged 7.1 percent, accounting for almost 70 percent of the gains in retail sales, the trade ministry said. Prices at the pump climbed 11 percent in May from a year earlier, according to the Tokyo-based Oil Information Center. That adds 715 yen ($6.16) to the cost of filling the tank of a Corolla compact, Toyota Motor Corp.'s top-selling vehicle...

Sales of electronics, including flat-screen televisions and DVD recorders, rose 0.4 percent in May from a year earlier on a "World Cup effect," the trade ministry said. Sales of clothing dropped 2.5 percent, cars slipped 2.4 percent and food and drink declined 1.1...

On a seasonally adjusted basis, retail sales climbed 0.6 percent from April, the first gain in four months, the trade ministry said.

The Japanese need the DVD recorders to go along with the flat-screen TVs to watch the World Cup, but the British don't. From Reuters:

British retail sales growth held steady at a 1-1/2 year high in June as the World Cup soccer tournamant [sic] continued to lift sales of televisions and food, a Confederation of British Industry showed on Wednesday.

The CBI distributive trades sales balance held steady at +9 in June. That was marginally lower than expected but marked the third consecutive positive reading and equalled the May balance which was the highest since May 2004.

Retailers also expect sales growth to hold up next month, with the July expectations balance also coming in at +9.

So what happens to retail sales after the World Cup?

It's not just TV sales that may drop. MP3 players are already seeing saturation, at least in China. From Xinhua Online:

Recent data from German-based GfK research institute shows that the market for MP3 players in China's seven major cities has fallen over the past three months.

The sales of MP3 players in Beijing, Shanghai, Guangzhou, Chengdu, Wuhan, Shenyang and Xi'an have dropped an average of 12 percent in the past three months, China Business News reported on Tuesday.

And that is despite strong overall retail sales growth in China.

Retail sales of China's consumer goods grew 14.2 percent year on year to 617.6 billion yuan (77 billion US dollars) in May, the National Bureau of Statistics said Tuesday in its monthly report.

Saturation in demand for MP3 players could be hitting Apple too. Yesterday, Apple's shares fell to an eight-month low after a Wall Street analyst said updated versions of the iPod may be delayed. That is on top of other problems facing the top maker of MP3 players -- such as competition and falling margins -- as detailed by MarketWatch's Herb Greenberg.

Hanging over all this is the fact that consumer spending in the US is under threat from a slowdown in the housing market. From Reuters:

The Mortgage Bankers Association said its seasonally adjusted index of mortgage application activity for the week ended June 23 decreased 6.7 percent to 529.6 from the previous week's 567.6.

Borrowing costs on 30-year fixed-rate mortgages, excluding fees, averaged 6.86 percent, up 0.13 percentage point from the previous week, its highest level since April 12, 2002 when it reached 6.92 percent.

The MBA's seasonally adjusted purchase mortgage index fell 6.2 percent to 389.0.

The purchase index, which is considered a timely gauge of U.S. home sales, was substantially below its year-ago level of 477.4.

The group's seasonally adjusted index of refinancing applications decreased 7.5 percent to 1,356.0. A year earlier the index stood at 2,529.2.

US data mixed but strong European data point to more rate hikes

The data from the US yesterday were mixed. From Reuters:

The National Association of Realtors (NAR) said sales of existing homes slipped to an annualized rate of 6.67 million units, 1.2 percent below April's pace and 6.6 percent below the pace of 7.14 million units a year ago...

The Conference Board said its consumer confidence index rose to 105.7, from an upwardly revised May reading of 104.7, higher than a median forecast by economists polled by Reuters for a reading of 103.5...

Separately, the Federal Reserve Bank of Richmond said its monthly composite manufacturing index rose to 4 in June from 1 in May.

Also the Chicago Fed said on Tuesday its Midwest manufacturing index slipped in May to 106.0 from April's downwardly revised 106.2.

The data from the UK were relatively positive. Again from Reuters:

The British Bankers' Association said [mortgage] approvals...totalled 81,298 in May, a rise of 20 percent from 67,702 in May 2005. The figures are not seasonally adjusted...

Net credit card lending fell by 251 million pounds but the BBA said this was offset by a stronger-than-usual rise in new lending on personal loans and overdrafts, perhaps indicating consumers are beginning to shy away from exorbitant interest rates.

Meanwhile, Bloomberg reports that Italian business confidence rose in June.

The Isae Institute's confidence index rose for a 13th month to 98.9, the highest since December 2000, from a revised 97, the institute said today in Rome. The gauge was expected to fall to 96.3, the median estimate of 25 economists surveyed by Bloomberg showed.

As did Germany's.

The Ifo economic research institute in Munich said its confidence index, based on a survey of 7,000 executives, rose to 106.8, the highest since February 1991, from a revised 105.7 in May. Economists expected a decline to 105, according to the median of 44 estimates in a Bloomberg survey...

Import-price inflation accelerated the fastest pace in almost six years in May, driven by increased costs for raw materials, Germany's Federal Statistics Office said today. Producer prices rose the most in 24 years last month...

No wonder ECB officials are sounding hawkish.

"All the recent data indicate that risks to price stability are on the upside and have increased," [ECB council member Nicholas] Garganas said in an interview in Basel, Switzerland. "I would not rule out a higher adjustment to rates than 25 basis points," nor quickening the pace of increases from once every quarter, he said.

US new home sales up, German inflation and leading index up

Like much of the rest of the US economy, the US housing market is surprising many by its resilience. From Reuters:

Sales of new single-family U.S. homes again defied predictions of a slowdown in May and rose 4.6 percent...

Still, compared with a year earlier, the May sales pace was down 5.9 percent.

The May median sales price for new single-family homes fell 4.3 percent from April to $235,300, a figure that was nonetheless 3.1 percent above the year-ago median price of $228,300.

The closely watched supply of new homes for sale at the end of May fell 0.7 percent to 556,000 from a downwardly revised 560,000 in April, which was a record level.

The homes-for-sale figure represented a 5.5 months' supply at the current sales pace, compared to a 5.8 months' inventory in April.

There was also no sign of cooling from Germany yesterday. From Bloomberg:

Inflation in Germany, Europe's largest economy, accelerated in June, strengthening the case for the European Central Bank to raise interest rates.

Consumer prices in Germany climbed 2 percent from a year earlier, the Federal Statistics Office in Wiesbaden said in a statement today. That matches the median estimate of 38 economists in a Bloomberg News survey. From a month earlier, prices rose 0.2 percent.

And the economic outlook for Germany remains good, according to the Conference Board's leading index for the country.

The Conference Board announced today that the leading index for Germany increased 0.3 percent and the coincident index remained unchanged in April.

And there certainly does not appear to be any cooling in China. From AFP/CNA:

China's economy will grow by 10.3 percent in the first half of 2006, then slow marginally for a full-year expansion of 10 percent, the central bank said in a new report.

At the same time, inflation will climb slowly, registering 1.3 percent in the first six months of the year and 1.7 percent for the 12 months, according to the report, from the People's Bank of China's research bureau.

US durable goods orders fall but Fed likely to hike anyway

The data on US durable goods orders for May were mixed. Total orders fell 0.3 percent but excluding transportation, orders rose 0.7 percent while nondefense capital goods orders excluding aircraft rose 1.0 percent.

Some economists saw little in the data to deter the Federal Reserve from another rate hike this week, according to Reuters.

Economists said the headline number was disappointing, but would not deter the Federal Reserve from a 17th consecutive interest rate hike when its policy-setting Federal Open Market Committee meets next Wednesday and Thursday...

"I would look past the fact that orders declined and point to ex-transportation, which was up," said Ken Mayland, president of Clearview Economics LLC in Pepper Pike, Ohio. "Manufacturing continues to be in darn good shape. Business is good in manufacturing."

Others saw it a little differently.

"The headline number was a negative surprise, there's just no getting around that, and you had a downward revision the previous month," said Michael Woolfolk, currency strategist at the Bank of New York. "Leading indicators yesterday suggest a slowing of the economy over the next three to six months, and this report fits in line with that."

Meanwhile, in his mid-year forecast, John Mauldin also says he thinks that the US economy is headed for a slowdown.

Between the central banks of the world almost universally tightening, commercial banks poised to tighten and the US housing market looking like it is going to slow as interest rates rise, it is very likely the US economy is going to slow down in the last half of the year. The question is, "How much?"

I do not think we will be in an actual recession by the end of the year. But a recession is not out of the question for 2007. If the Fed does not have to go too far (and 5.5% may be too far given the other conditions in the world), then we could see a slowdown on the order of what we saw in the mid-90's. We will have to watch the yield curve and other indicators.

Economic data soft but rates expected to rise

Yesterday's economic data from the US and Europe were mostly negative. From Reuters:

A key private forecasting gauge for the U.S. economy fell by a larger-than-expected 0.6 percent in May, suggesting that growth may be slower during the summer months and more vulnerable to punishing hurricanes.

The sharp fall in the Conference Board's Composite Index of Leading Economic Indicators outpaced expectations for a 0.4 percent fall in May and was the biggest drop since a 0.8 percent plunge in September 2005 after Hurricane Katrina smashed the U.S. Gulf Coast...

For the week ended June 17, first-time claims for state unemployment insurance benefits rose to a seasonally adjusted 308,000 from an upwardly revised 297,000 claims the previous week, the Labor Department said...

The Chicago Fed said its National Activity Index slipped to minus 0.16 in May from a downwardly revised 0.26 in April as both production and employment indicators faltered.

And on the UK economy:

The Confederation of British Industry said its monthly manufacturing orders books balance held steady at -12 in June, as expected by economists.

Firms' expectations for future output rose to +14 in June from +10 in May, the brightest since February 2005. However, the CBI's export orders books balance fell to -3 in June from 0 in May.

AFX/Forbes reports eurozone industrial orders:

EU statistics agency Eurostat reported a fall of 0.2 pct in April from March and a rise of 4.4 pct year on year...

Excluding the volatile [heavy transport equipment] component, orders rose 2.3 pct from March.

But the softness in the data is not stopping some analysts from forecasting a 6-percent fed funds rate.

On Thursday, Barclays became the first primary dealer bank to predict 6 per cent rates before the year end. "We have become less convinced that the FOMC will be comfortable keeping rates at 5.5 per cent in August as growth remains strong and core inflation continues to move higher," the bank's economists said...

Last week, economists at Lehman Brothers raised their Fed funds forecast to 5.75 per cent. Others with a 6 per cent peak include JPMorgan and Credit Suisse, although both expect that rate some time next year.

Japanese stocks surge

Japan has not been an emerging economy for many years now, but for the past few weeks -- some might say months -- its stock market has been behaving almost like that in an emerging one. Today, the Nikkei 225 jumped 3.4 percent to close at 15,135.69.


The recent economic news has been quite positive. While a government survey released yesterday found that optimism among Japan's largest manufacturers slipped in the second quarter, today, the Ministry of Economy, Trade and Industry reported that its all-industries index rose 1.3 percent in April from March and the Ministry of Finance reported that Japan's trade surplus soared on the back of an 18.9 percent rise in exports and a 17.9 percent rise in imports.

An imminent but gradual rise in Japan's interest rates now looks likely.

US and UK housing markets steady, German producer price inflation rises

The US housing market may be cooling, but it is not quite collapsing yet. From Reuters:

The pace of U.S. housing construction rose more than expected in May after three months of declines, but permits for future projects fell, a government report showed on Tuesday.

Economists said the data confirms a gradual slowing of the U.S. housing sector.

The Commerce Department said housing starts rose 5 percent in May to a 1.957 million unit annual pace from an upwardly revised 1.863 million unit rate in April.

However, permits for future groundbreaking, an indicator of builder confidence, fell 2.1 percent to a 1.932 million unit pace in May, the lowest since November 2003 and the first time since January that total housing permits fell below starts.

And the UK housing market remained firm in May, as Reuters reports.

Underlying mortgage lending rose by its biggest amount in just over two years in May, British Bankers' Association data showed on Tuesday, suggesting a property market revival this year remains intact.

Net mortgage lending rose 5.7 billion pounds, up sharply from a revised 5.1 billion in April and also well above the average 5.1 billion pound increase over the past six months. It was the biggest rise since April 2004...

The BBA also said underlying credit card lending fell by 300 million pounds, its second big drop in the past three months. Unsecured lending rose by 400 million pounds.

The Building Societies Association said in a separate release that mortgage approvals rose to a seasonally-adjusted 4.514 billion pounds in May from 4.473 billion in April.

And the Council of Mortgage Lenders said gross mortgage lending was 28.7 billion pounds in May, the highest monthly figure since July 2004's 28.9 billion.

However, broad money supply growth in May slowed to a 11.8 percent annual rate from 13.1 percent in April, according to the Bank of England. The growth rate in M4 lending fell to 12.4 percent from 12.7 percent in April.

Meanwhile, German producer prices rose at its fastest annual rate in 24 years in May. From Bloomberg:

Goods from plastics to newsprint were 6.2 percent more expensive in May than a year earlier, compared with 6.1 percent more in April, the Federal Statistics Office in Wiesbaden said today. That's the most since June 1982. From April, prices rose 0.1 percent...

Economists expected producer prices to gain...6.4 percent, according to the median of 34 forecasts in a Bloomberg News survey. Excluding energy, producer prices increased 0.4 percent from April and 2.3 percent from a year earlier.

However, Bloomberg's Matthew Lynn thinks that it is Spain's economy that we should be worried about.

For a decade, the Spanish have been riding a rising tide of cheap money, fuelling a construction, property and now a mergers and acquisitions boom. It can't be long before this tide turns. When it does, it is likely to be messy -- not just for Spain but for the whole of Europe as well...

In decades past, Spain might have been peripheral to the European economy. France, Germany and Italy were the countries that mattered. Not any more. According to Lombard Street calculations, between 2003 and 2005 39 percent of the growth in the euro-area economy came from Spain. Without it, the euro region would scarcely have expanded at all.

When Spain does turn down, much of the growth in the euro area is going to disappear at a stroke.

Despite weakness in US housing, recession not yet inevitable

Will the current weakness in the United States housing market lead to a recession? The jury is still out on this.

The National Association of Home Builders/Wells Fargo Housing Market Index (HMI) -- a gauge of builder perceptions of current and future single-family home sales in the US -- showed a fall to 42 in June from 46 in May. The June reading is the lowest since April 1995 and is well down from its June 2005 peak of 72.

The trend in the HMI is similar to that of actual new single-family home sales. Despite a slight rebound in March and April, the number of new single-family homes sold in the first four months of 2006 have been eleven percent less than that in the corresponding period in 2005.

These trends show weakness in the housing market and do not bode well for consumer spending. The HMI and the number of new home sales have both correlated well with consumer spending in past cycles, as shown in the following chart.


Indeed, economic data released last week suggest that consumer spending, especially in real or inflation-adjusted terms, may already be slowing. May retail sales rose just 0.1 percent over April. The University of Michigan's index of consumer sentiment, although rising to 82.4 for June from May's final reading of 79.1, is still well below levels in the 90s or more that prevailed during much of the earlier part of the current expansion.

And consumer price inflation accelerated in May. Overall inflation rose to an annual rate of 4.2 percent in May from 3.5 percent in April while core inflation -- excluding food and energy -- rose to an annual rate of 2.4 percent in May from 2.3 percent in April.

Higher inflation hurts real consumer spending not only because nominal spending is offset by a larger inflation rate but also because it puts pressure on the Federal Reserve to keep raising interest rates, hurting the housing market and consumer demand.

However, while real consumer spending may be slowing, an imminent consumer-led recession is far from inevitable.

The above chart also shows that the extent of the downturn in the housing market so far is similar to that in 1994-95. At that time, the housing market weakened in 1994 as the Federal Reserve raised interest rates. However, by 1995, the Federal Reserve had stopped tightening monetary policy, allowing the housing market to recover. As a result, growth in real consumer spending stayed positive on a year-on-year basis throughout that period and there was no recession.

Today, with Federal Reserve officials publicly stating that they expect inflation to cool and most economists expecting just one or two more interest rate hikes from the Federal Reserve, there is a chance that the 1994-95 pattern could be repeated. That in turn means that a consumer-led recession could yet be averted.

US consumer sentiment up, European industrial output down, China tightens

The US economy received some good news yesterday. From Reuters:

The University of Michigan's preliminary June index of consumer sentiment read 82.4, up from May's final reading of 79.1 and above Wall Street expectations for a reading of 79.0...

Before the June sentiment data's release, the Commerce Department said the U.S. current account deficit -- which measures international transactions as well as physical imports and exports -- narrowed more than expected in the first quarter to $208.7 billion, as exports rose more than imports.

But the news from Europe was not so good. From Eurostat:

Seasonally adjusted industrial production fell by 0.6% in the euro area in April 2006 compared to March. Production grew by 0.6% in March after remaining stable in February. Output in the EU25 fell by 0.1% in April, after increasing by 0.5% in March and remaining stable in February.

In April 2006 compared to April 2005, industrial production rose by 1.9% in the euro area and by 2.1% in the EU25.

Meanwhile, the People's Bank of China has -- not surprisingly after the recent economic data -- decided to raise its reserve requirement for commercial banks by 0.5 percentage points to eight percent from July 5.

Stocks do very well despite mixed economic data

The economic data out of the US yesterday were mixed. From Reuters:

The Philadelphia Federal Reserve Bank said the pace of business expansion in the region slowed and prices paid by manufacturing businesses also dipped. But its new orders index jumped sharply this month from May's level.

Earlier, the New York Fed said activity among New York manufacturers and prices they paid showed a surprising jump in June, while a Labor Department report showed initial claims for unemployment benefits dropped last week to the lowest in nearly four months, a sign of resilience in the labor market.

The reports overshadowed data from the Federal Reserve showing an unexpected decline in U.S. industrial output for May and cemented expectations that the Fed will raise rates again by a quarter-percentage point when it meets later this month.

Nevertheless, stocks did very well yesterday.

The Dow Jones industrial average rose 198.27 points, or 1.83 percent, to 11,015.19, closing above the 11,000 level for the first time in more than a week. The Standard & Poor's 500 Index made its biggest one-day gain in more than 2-1/2 years, rising 26.12 points, or 2.12 percent, at 1,256.16. The Nasdaq Composite Index was up 58.15 points, or 2.79 percent, at 2,144.15...

Speaking before the Economic Club of Chicago, Bernanke said inflation expectations had "fallen back somewhat" and that the impact of high energy prices on the economy has been limited. That offset worries from earlier this week when core consumer and producer price data rose above expectations.

But if you were an equity investor, the place to be yesterday was Colombia. From Reuters:

Colombian stock prices rose a record 15.8 percent on Thursday as investors snapped up shares hit by a recent flight to safe-haven assets prompted by higher world interest rates.

If stocks around the world were hot yesterday, the same could be said about most of the economic data.

The Bank of Japan left both its economic assessment and interest rates unchanged yesterday as its tertiary index rebounded 1.3 percent in April after falling the two previous months and its index of leading economic indicators was revised upward to 54.5 from the preliminary reading of 50.0.

However, the Chinese authorities may have to do some cooling fast after data showed that urban fixed asset investment rose by 30.3 percent in the first five months of 2006 compared with the same period last year, accelerating from the 29.6 percent recorded in the first four months.

The European Central Bank also worried about inflation in its latest monthly report, summarised by Bloomberg.

"Upside risks to price stability over the medium term prevail," the Frankfurt-based central bank said in its monthly report published today. "Interest rates are still low by historical standards" after last week's increase...

Economic growth "is broadening and becoming more sustained," the ECB said. "The conditions are in place for growth in the euro area to remain close to its trend potential rate, despite the impact of the rise in oil prices." The ECB puts the region's potential growth rate at around 2 percent.

The ongoing World Cup appears to have made many in the UK happy though, and not just because England won its match yesterday; data released yesterday showed that retail sales rose 0.5 percent last month, boosted by a jump in electrical goods, including flat-screen televisions. On the other hand, a survey by the Confederation of British Industry and property advisers GVA Grimley showed that demand for commercial property has slowed to its weakest in a year.

Inflation not cooling yet

The inflation data continue to look bad. From Reuters:

Rising rents pushed up U.S. core consumer prices a steep 0.3 percent for a third straight month in May, according to a government report on Wednesday that cemented expectations of higher interest rates.

Overall consumer prices rose an even swifter 0.4 percent, as surging energy costs continued to pressure U.S. households, the Labor Department report showed...

Prices for U.S. government bonds fell sharply as traders saw the report boosting chances of further interest rate increases from the Federal Reserve. Interest rate futures markets fully priced in a rate rise at the central bank's next meeting on June 28-29 and began to brace for even more.

However, U.S. stock markets -- battered in recent sessions by inflation jitters -- managed to shake off the news with help from upbeat brokerage reports, while the dollar fell.

Separately, the Fed said in its "beige book" report that U.S. economic growth appeared to have slowed recently, but that inflation seemed to have gotten a better foothold, as well.

And Calculated Risk highlights the fact that the Mortgage Bankers Association's Market Composite Index rose last week, a respite for the housing market and thus, the economic outlook.

On the other hand, Paul Kasriel says that retail sales, reported a day earlier, fell 0.6 percent in May and 0.3 percent in April after adjusting for goods price inflation.

Elsewhere in the world, there were few signs of cooling.

China's industrial production grew 17.9 percent in May from a year ago.

British wages rose at an annual rate of 4.4 percent in the three months to April -- the highest in a year -- although the jobless rate rose to 5.3 percent, and British house prices rose at their fastest pace in two years in the three months to May according to the Royal Institution of Chartered Surveyors.

In France, the consumer price index rose 0.4 percent in May and 2.1 percent from a year earlier, the annual rate rising from a 1.7 percent rate in April, while the Bank of France yesterday raised its forecast for growth of the French economy in the second quarter to 0.7 percent from 0.6 percent and reported that its index of French business confidence had risen to 111 in May from 106 in April.

Yet more inflation fears

There was no respite from inflation fears yesterday. Reuters reports US producer price inflation and more:

U.S. producer prices rose just 0.2 percent last month as food costs fell, but prices outside of food and energy rose a steeper-than-expected 0.3 percent. Retail sales in May rose just 0.1 percent, matching Wall Street expectations, with declines in auto, furniture and building material sales...

Meanwhile motor vehicle and parts sales fell 1.6 percent, the largest drop since February. Excluding cars and parts, retail sales rose 0.5 percent, in line with expectations.

When cars, parts, and gas were excluded, retail sales rose 0.3 percent...

A separate Commerce Department report showed U.S. business inventories rose a smaller-than-expected 0.4 percent in April, tempered by a drop in the stocks of total retail trade and motor vehicles and parts.

However, a paper by Edward Liu and Bill Cara argues that "the growth rate of the PPI will actually turn negative in November – not increase as traders believe today".

The growth rate of the production price index is expected to descend steadily... Such a decline in PPI would be very helpful in stabilizing the U.S. consumer prices. The growth rate of the consumer price index will likely moderate significantly and maintain at the current level or even decline...

According to the RiskFile model, the deceleration of the economy might be more serious than most economists expect... While not going into recession, we believe that the U.S. GDP will fall to a level of just over +1.0 pct in 1Q07.

Perhaps so. At least in the UK, economists appear relatively unconcerned about the latest rise in the inflation rate.

The Office for National Statistics said consumer prices rose 0.5 percent in May, taking the annual rate to 2.2 percent, the highest since October and above forecasts for 2.1 percent.

But analysts said that did not necessarily mean interest rates would soon rise.

The Bank's Governor Mervyn King, who would have had advance warning of the figures, said late on Monday that inflation data can be volatile and higher utility bills would also have a moderating impact on consumer spending.

"Soothing comments on inflation from BoE Governor Mervyn King last night should help to take some of the sting out of this report," said Gavin Redknap, economist at Standard Chartered Bank.

"The result still keeps inflation just about on course to meet the Bank's expectations for the end of Q2, so immediate policy implications should be somewhat limited."

In any case, in Germany at least, investor confidence is declining. From Bloomberg:

German investor confidence fell for a fifth month in June on concern that rising interest rates and near-record oil prices will cool growth in Europe's largest economy.

An index of institutional and analyst expectations dropped to 37.8, the lowest since July 2005, from 50 in May, the ZEW Center for European Economic Research said today in Mannheim. Economists expected a decline to 45, the median of 34 estimates in a Bloomberg News survey showed. The measure has been retreating since reaching a two-year high of 71 in January.

Stocks fall on renewed inflation fears

Like its soccer team at the World Cup, US stocks were pummelled yesterday. From Reuters:

Stocks dropped on Monday amid persistent worries about rising interest rates and slower economic growth after the latest warnings on inflation from Federal Reserve officials...

The Dow Jones industrial average closed down 99.34 points, or 0.91 percent, at 10,792.58. The Standard & Poor's 500 Index was down 15.90 points, or 1.27 percent, at 1,236.40. The Nasdaq Composite Index was down 43.74 points, or 2.05 percent, at 2,091.32...

Sandra Pianalto, president of the Federal Reserve Bank of Cleveland, said a sustained rise in core consumer prices would exceed her comfort level.

Federal Reserve Board Governor Susan Schmidt Bies said the Fed is very data-dependent now, and that the economy is at a turning point which makes it difficult to know when the Fed will stop raising interest rates after two years of increases.

And prices are rising in the UK too -- house prices as well as producer prices.

British factory gate inflation picked up more than expected in May to its fastest rate in eight months as the cost of petrol hit a record high, official statistics showed on Monday.

The Office for National Statistics said that output prices rose 0.3 percent on the month in May, taking the annual rate up to 3.0 percent from 2.5 percent. Analysts had predicted 2.8 percent.

Maybe that is why Bank of England Governor Mervyn King says that "global interest rates may have been too low for too long".

"During the fastest three-year period of world economic growth for a generation, monetary policy around the world may have simply been too accommodative," said King in a speech to business leaders in Edinburgh. "Even though the monetary stimulus around the world is now being withdrawn, its effects are still being felt."

Japanese data show higher growth, higher prices

Japan's first quarter GDP growth was revised up today. From Bloomberg:

Japan's economy grew at an annual 3.1 percent pace in the first quarter, buoyed by the second- biggest increase in corporate spending since 1990.

The figure for gross domestic product released by the Cabinet Office in Tokyo today was in line with the 3.2 percent forecast of 20 economists surveyed by Bloomberg News. It was revised from an initial 1.9 percent estimate made on May 19.

But Japan's growth is being accompanied by upward pressure on producer prices.

An index of prices that companies pay for energy and raw materials climbed 3.3 percent in May from a year ago, the fastest pace since 1981, the Bank of Japan said in a separate report in Tokyo today. The median estimate of 24 economists surveyed by Bloomberg News was for a 2.8 percent increase.

And imports are surging, cutting the current account surplus. From AFX/Forbes:

Japan's current account surplus in April fell 20.2 pct from a year earlier to 1.28 trln yen, dropping for the first time in two months, the Ministry of Finance said...

Exports surged 11.4 pct to 5.84 trln yen, up for the 29th straight month, while imports jumped 23.2 pct to 5.08 trln yen, the 26th consecutive monthly increase.

The goods and services account posted a surplus of 258.5 bln yen versus a surplus of 481.1 bln a year before.

An end to zero interest rates is still expected by July, although consumer confidence dipped in May.

The consumer confidence index worsened to 49.8 in May from 50.0 in April, the first fall in two months, the Cabinet Office said.

There was also trade and inflation data from China today. From Bloomberg:

China posted a record $13 billion trade surplus in May and inflation accelerated, increasing pressure on the government to allow the yuan to strengthen.

The surplus topped the $12 billion median estimate of 21 economists in a Bloomberg News survey and widened from $10.5 billion in April as exports jumped 25.1 percent. A separate government report showed consumer prices rose 1.4 percent from a year earlier, the most in four months.

US trade deficit widens as global economy stays hot

The US trade deficit should stabilise when the economy moderates. But not yet. From Reuters:

The U.S. trade gap widened to $63.4 billion in April, lower than the $65 billion shortfall Wall Street analysts had expected. However, another government report put import prices up 1.6 percent in May, more than twice the increase expected...

April imports grew 0.7 percent from the previous month to $179.1 billion, the second highest on record. Oil and other petroleum products accounted for nearly $23.4 billion of the total, although import volumes fell as prices rose...

U.S. exports, reflecting stronger growth overseas and a decline in the value of dollar in recent years, totaled $115.7 billion in April, just shy of the record high set in March.

Some good commentaries on the trade numbers from Brad Setser and Menzie Chinn, both of whom commented on the fact that the non-oil trade balance has stabilised recently. And that is notwithstanding the fact that the Chinese economy -- which is responsible for much of the growth in the US non-oil trade deficit -- is still red hot, with outstanding bank loans surging 15.97 percent year-on-year in the first five months of the year and producer prices rising 2.4 percent year-on-year in May.

Other economies are also doing well, with Japan yesterday reporting a bigger-than-expected 10.8 percent rise in core private-sector machinery orders in April and Germany reporting a 1.6 percent rise in industrial production in April, the most in more than two years. But French industrial production fell 1.4 percent in April.

Markets fall as central banks raise rates

Official interest rates continued to rise yesterday, so markets went the other way. From Bloomberg:

Stocks slumped worldwide, led by emerging markets, and commodities fell on concern that central banks will stifle economic growth as they raise interest rates...

Morgan Stanley Capital International's World Index, a gauge of 23 developed markets, fell 1.7 percent to 1276.07 as of 5:35 p.m. in New York. A rebound in U.S. stocks limited the decline. The MSCI Emerging Markets Index tumbled 4 percent to 697.33.

Copper, aluminum and zinc led declines in metals and crude oil dropped for a third day in New York. Shares of BHP Billiton, BP Plc and other commodity producers were the day's worst performers. Bonds and the dollar gained...

ECB policy makers...lifted the refinancing rate to 2.75 percent... Denmark's central bank raised its benchmark rate by a quarter point, to 3 percent... India lifted its benchmark interest rate by a quarter point, to 5.75 percent. South Africa raised its rate by half a point, to 7.5 percent. A quarter-point increase in South Korea brought its rate to 4.25 percent, a three-year high.

Turkey and Thailand both pushed rates higher yesterday. The Turkish central bank raised borrowing costs by 1.75 points, more than double analyst forecasts, to 15 percent.

However, there was no change in interest rates in New Zealand and in the UK. For the latter, expectations for a hike in interest rates later this year would probably also have been curbed by signs that the UK housing market may be slowing again and by a fall in manufacturing output in April.

And there is uncertainty in monetary policy in Japan too. From Reuters:

Prospects of an imminent end to zero interest rates in Japan dimmed on Thursday as Tokyo stocks plunged, even though economic data pointed to steady growth and a top central banker put on a brave face over market volatility. The Nikkei share average fell 3 percent on Thursday alone, bringing its cumulative losses from a five-year high in April to 17 percent and prompting calls for the Bank of Japan to keep interest rates at zero to support the economy.

"We would like the BOJ to take an appropriate monetary policy and support the economy," Chief Cabinet Secretary Shinzo Abe told a news conference.

"More specifically, we would like the BOJ to support the economy by continuing its zero rate policy," said Abe, a front-runner in the race to succeed Prime Minister Junichiro Koizumi in September...

The BOJ is widely expected to raise short-term money rates from present levels near zero next month, and Deputy Governor Kazumasa Iwata's remarks on Thursday suggested he was concerned about leaving monetary policy easy for too long.

"We must not ignore the risk of swings in the economy and prices becoming big in the mid- to long term as we maintain a very accommodative monetary policy for a long period," Iwata told business leaders in Akita, northern Japan.

On the stock market sell-off, Iwata blamed it on "position adjustments", though he said the BOJ would closely examine financial markets in making policy decisions.

Earlier in the day, BOJ data showed Japanese bank lending grew solidly in May.

The balance of outstanding loans held by Japan's four main categories of banks, including "shinkin" credit unions, rose 1.2 percent in May from a year earlier to 444.0265 trillion yen ($3.913 trillion)...

Excluding special factors such as loan write-offs, the loan balance rose 2.0 percent from the same month a year earlier.

Separate BOJ data showed on Thursday that Japan's most widely watched measure of money supply -- M2 plus certificates of deposit (CDs) -- rose 1.4 percent in May from a year earlier.

Interest rates expected to head higher

The macroblog points out that expectations for further rate hikes by the Fed continue to rise. But the economic data reported yesterday were not unambiguously pointing to higher rates. While US consumer credit in April saw its biggest gain since June 2005, home loan refinancing applications last week sank to their lowest this year and new home mortgages barely budged.

Japan is also expected to see higher interest rates soon as its economic expansion is perceived to be sustainable, despite the fact that its leading index for April was at 50, unchanged from March.

There are interest rate decisions in Europe later today. The ECB is widely expected to raise rates, and the better-than-expected 1.4 percent rise in retail sales in the euro zone in April reported yesterday would have boosted those expectations.

The BoE is not expected to raise rates today, although recent economic data from the UK have also been relatively buoyant. A survey has found that the consumer services business expanded at its fastest pace in more than a year in the last three months, while the British Retail Consortium reported yesterday that its shop price index for May showed overall prices were up from April, their first monthly gain so far this year.

Devilish date downs Dow

On the 6th day of the 6th month of the 6th year of the century, the Dow Jones Industrial Average fell below 11,000, if only momentarily. Reuters reports the devilish details:

Stocks fell on Tuesday, taking the Dow below 11,000 for most of the afternoon, as investors grappled with the prospect of more interest-rate increases and slowing economic growth.

Late in the session, stocks trimmed most of their losses and the Dow managed to close just a whisker above the psychologically important 11,000 mark. It hadn't fallen below that level in three months...

The Dow Jones industrial average was down 46.58 points, or 0.42 percent, to end at 11,002.14. The Standard & Poor's 500 Index was down 1.44 points, or 0.11 percent, to finish at 1,263.85. The Nasdaq Composite Index was down 6.84 points, or 0.32 percent, to close at 2,162.78.

Despite the late recovery in the market, there were bad omens.

In Tuesday's session, the major U.S. stock indexes fell below key technicals levels -- a move analysts say portends more downside pressure in the days ahead...

While the Dow fell below the 11,000 level, the S&P 500 slid under its 200-day moving average, a long-term trend line that measures a security's or a stock index's resilience.

One technical analyst said the next key level to watch on the Nasdaq is 2,025, and noted that breaking that level would take the index lower. The Dow's next support base is 10,750, he said.

Comments from Fed officials continued to keep markets uneasy.

William Poole, president of the Federal Reserve Bank of St. Louis, said in a Wall Street Journal interview published on Tuesday that if inflation expectations keep rising, slower growth alone may not be enough to reduce actual inflation.

Fed Governor Susan Bies, talking to a bankers' group, said inflation, excluding food and energy, has been running in the high 2 percent range for three quarters, "which personally makes me very uncomfortable."

Otherwise, the economic data yesterday were not too bad, particularly in Europe. The euro zone services PMI rose marginally to 58.7 in May from 58.3 in April while like-for-like retail sales in the UK grew by 3.6 percent on a year earlier in May -- the strongest since May 2004 -- and total sales rose 6.2 percent.

Expectations for a Fed pause rewind

Talk about volatility.

After Friday's weak US jobs number raised expectations of a pause in Fed tightening, one speech by Chairman Ben Bernanke yesterday changed everything. From Reuters:

The U.S. Federal Reserve needs to be vigilant to make sure inflation stays under control even as the U.S. economy starts to shift to a slower pace of growth, Fed Chairman Ben Bernanke said on Monday...

While welcoming signs of cooler growth, the U.S. central bank chief stressed concerns over core inflation, saying it had reached levels that "if sustained" would put it at or above the upper end of the range consistent with price stability...

Financial markets saw the comments as suggesting the Fed was likely to raise benchmark overnight interest rates for a 17th consecutive time at its upcoming meeting on June 28-29.

The blue chip Dow Jones industrial average closed off nearly 200 points, or 1.77 percent, at 11,048.72 as investors braced for higher credit costs. Prices for U.S. government bonds also fell, while the dollar strengthened.

Bets in interest rate futures markets pushed chances of a quarter-percentage point June rate hike, which would take the key federal funds rate to 5.25 percent, up to 76 percent. The probability of a move stood at just 48 percent on Friday.

Yesterday's ISM report on the service sector tells the same story of slowing growth but higher inflation. Again from Reuters:

The Institute for Supply Management's services index eased to 60.1 in May, in line with forecasts and down from 63.0 in April...

The survey's prices-paid index spiked to 77.5 from 70.5. That was its highest since September, when Hurricane Katrina caused a huge jump in energy costs, and comes at a time when investors are watching inflation closely to gauge whether the Federal Reserve will keep raising interest rates.

In the UK, the service sector also slowed, albeit slightly.

The Chartered Institute of Purchasing and Supply/RBS business activity index, which is closely watched by the Bank of England's Monetary Policy Committee, eased to 59.2 in May from the two-year high of 59.7 struck in April.

US May employment and other recent data point to Fed pause

Indications of a slowdown in the US economy are getting stronger. Reuters reports US May employment gains:

U.S. employers added only 75,000 new jobs in May, the Labor Department said on Friday in a report that signaled slower economic growth and led financial markets to slash bets on further interest-rate increases...

The unemployment rate, however, was a bright spot. It unexpectedly slipped to 4.6 percent -- the lowest since July 2001 -- from 4.7 percent in April...

Average hourly earnings edged up just 1 cent, or 0.1 percent, the length of the workweek dropped back from a 3-1/2 year high struck in April, and job growth for the prior two months was revised down by a net 37,000.

Factory orders are telling a similar slowdown story, although the story, as reported by Reuters, is less bad than feared earlier.

New orders at U.S. factories fell a smaller-than-expected 1.8 percent in April as orders for aircraft, machinery, and computers and electronic products slipped, a government report showed on Friday.

Wall Street analysts polled by Reuters were expecting a 2.2 drop in factory orders. The April slide was nevertheless the biggest decline since January, when they fell 2.7 percent.

Orders for durable goods, expensive items meant to last three year or longer, slipped 4.4 percent, revised from a 4.8 percent slip reported last week.

March factory orders were revised down to a 4.0 percent gain from a previously reported 4.1 percent rise.

Fed-watcher and Bloomberg columnist John Berry thinks that the recent data "leaves the door open for the Fed to keep its target for the overnight lending rate at the June 28-29 meeting at the current 5 percent".

Paul Kasriel of Northern Trust goes one step further.

... The May employment report is part of a pattern of evolving weakness in economic growth... Therefore, we do believe the FOMC will stand pat at its upcoming June 28-29 meeting. Moreover, we are of the opinion that the FOMC’s next change in the fed funds rate will be to cut it -- probably at the December 12 meeting.

Global manufacturing expansion passed its peak?

The latest JPMorgan global report on manufacturing says that the global manufacturing expansion "passed its peak in May, as growth of output and new orders slowed and cost inflationary pressure mounted".

	April	May	Change
Global PMI	55.9	55.0	-
Output	58.4	57.5	-
New Orders	57.6	56.3	-
Input Prices	66.3	71.8	+
Employment	53.4	52.3	-

National PMIs for the major economies were as follows:

	April	May	Change
US	57.3	54.4	-
Eurozone	56.7	57.0	+
Japan	55.5	55.3	-
UK	54.0	53.2	-
China	52.7	52.8	+

There were other economic data coming out of the US yesterday. The summary from Reuters:

U.S. factory expansion eased in May to the slowest pace since August while April pending home sales slipped for the third straight month, reports showed on Thursday, indicating the red hot pace of economic growth at the start of the year may be cooling.

The housing and manufacturing reports combined with separate data released earlier showing a lower-than-expected increase in labor costs amid solid productivity gains suggest rising price pressures remain well contained.

Strong data from euro zone, mixed elsewhere

The US housing market is pointing to a slowdown in the economy, but most of the slowdown is yet to come. Reuters summarises yesterday's economic news from the US:

The National Association of Purchasing Management-Chicago said its business barometer rose to 61.5 in May -- the highest since October -- from 57.2 in April. Economists had predicted the index would fall to 56.0...

Markets lurched further to the "rate hike" side on Wednesday afternoon after the release of minutes from the May 10 meeting of the Fed's policy-making Federal Open Market Committee.

Although FOMC policy-makers showed uncertainty about how much more they would need to raise interest rates, they expressed enough worry about inflation to convince many traders that a 17th consecutive rate hike is on the way...

The Mortgage Bankers Association said its seasonally adjusted index of mortgage applications for the week ended May 26 fell 1.9 percent...

A flurry of reports suggested American consumers may be spending less at the shopping mall but, to no one's surprise, a lot more on gasoline.

MasterCard Advisors' Spending Pulse report for retail sales excluding autos was steady in May, against a 0.7 percent increase in April.

The economic news from the UK yesterday was similarly mixed. From Reuters:

Many economists predict the central bank will raise interest rates later this year -- perhaps as soon as August.

Their case was certainly boosted by a Confederation of British Industry survey showing retail sales picking up fast and set to do even better next month thanks to the World Cup tournament.

But that was offset by official data showing the number of mortgage approvals fell to 106,000 -- the lowest since September 2005 -- in a sign that the recent revival in the housing market is petering out.

GfK NOP's consumer confidence barometer also unexpectedly fell back to -5 from -4 in April as Britons became more pessimistic about their personal finances and were increasingly reluctant to make major purchases.

The Nationwide building society, meanwhile, said house prices eked out a 0.2 percent gain this month, more than in April but still bringing the annual rate down to 4.7 percent.

Yesterday's data from the euro zone, on the other hand, was unambiguously strong. From Bloomberg:

A European Union index of economic sentiment in consumers and companies in the dozen euro nations climbed to 106.7, up from 105.7 last month and the highest since April 2001, the EU statistics office in Luxembourg reported. In Germany, the continent's largest economy, retail sales rose 2.8 percent in April and joblessness had its biggest drop this year...

Inflation also stayed above the ECB's target of just below 2 percent for a 16th straight month in May, accelerating to 2.5 percent from 2.4 percent in the previous month, the EU's statistics office said in Luxembourg today. Economists had predicted the inflation rate would be unchanged.

While the euro zone's employment situation appears to be improving, it may not last. Not when even India's cheap labour may not be cheap enough -- see Andy Mukherjee's "India Badly Needs Jobs; Companies Hire Robots".