Valuations support stocks for now

Stock markets are not always correlated to the economy. Recent days have reminded us of this fact.

The report on first quarter gross domestic product for the United States, released by the Commerce Department on Friday, confirmed that the US economy is in a slowdown. Real GDP grew at an annual rate of just 1.3 percent, down from the 2.5 percent rate for the last quarter of 2006 and the 3.3 percent rate for all of 2006.

In spite of this, US stocks held steady on Friday. The Standard & Poor's 500 Index closed at 1,494.07 -- essentially flat for the day -- while the Dow Jones Industrial Average actually rose by 0.1 percent to another record high of 13,120.94 and the Nasdaq Composite also rose 0.1 percent to close at 2,557.21.

Some analysts are stumped by the resilience of the bull market in equities. They think that the economic weakness should translate to a weak stock market.

To a certain extent, these analysts are right. A weak economy usually translates into weak corporate earnings, which should in turn translate into weak stock prices.

Except that earnings have not been particularly weak. The latest estimates for first quarter earnings project over nine percent year-on-year growth, not too much deceleration from previous quarters. Overseas earnings have helped, since much of the rest of the world's economy remains strong.

These upward revisions to earnings have helped to boost stock prices, but relatively modest market valuations have probably also been important. Stock prices in the US have actually badly lagged earnings growth for the past few years. As a result, the price-earnings ratio on the S&P 500, around 30 at the beginning of this bull market, has now shrunk to about 18.

It is unusual for the P/E ratio to decline in a bull market. This has happened in this cycle because growth in earnings per share has far outpaced growth in both stock market prices and GDP.

This strong earnings growth has provided stocks with a valuation cushion. The equity earnings yield, the reciprocal of the P/E, now stands at 5.5 percent, higher than the yield on 10-year US Treasuries, which is at 4.7 percent. Until the current bull market, this has not happened since the 1970s.

Bonds are providing little competition to stocks as an investment vehicle, and this keeps stock prices well-supported. In fact, even if earnings fall by about 15 percent, the yield on stocks would still match the yield on Treasuries without prices having to adjust.

Of course, this does not mean that the stock market is out of the woods.

If the US economy weakens further and dips into a recession, earnings could deteriorate more than 15 percent. So far, economic weakness has been concentrated in housing, with residential investment falling 17 percent in the first quarter and contributing a full percentage point drop in GDP growth. If this weakness spreads to consumer spending or business spending, a full-blown recession becomes likely.

Alternatively, if the economy re-accelerates -- and many economists actually think it will -- then inflation could re-accelerate as well and cause interest rates to rise, potentially wiping out the yield advantage of equities. As it is, the price index for personal consumption expenditures excluding food and energy rose at a 2.2 percent rate in the first quarter, above the Federal Reserve's comfort zone. Faster economic growth would surely raise concerns about higher inflation and thus raise the risk of further Federal Reserve tightening.

The economy may not be having a decisive influence on stock prices, but it is far from irrelevant.

China tightens again

China announced another round of monetary tightening today. Xinhua Online reports:

The required reserve ratio for financial institutions engaged in deposit business will be raised by 0.5 percentage point as of May 15 to 11 percent, the People's Bank of China said on Sunday.

This is the fourth time the central bank has raised the deposit reserve ratio this year and the seventh time since last year in an effort to rein in excessive liquidity and cool the booming economy.

This is not likely to be the end.

"Raising the reserve ratio is a rather easy and flexible measure for the central bank, but it might need to raise interest rates if the nation's strong economic momentum and inflationary pressures continue in the second quarter," said Wang Xiaoguang, a researcher at the Economy Research Institute of the National Development and Research Commission, the top economic planner...

Li Xiaochao, spokesman of the National Bureau of Statistics, said recently that China is running the risk of shifting from relatively fast economic growth to an over-heated economy.

Li acknowledged that the Chinese government should take more small steps to ensure a stable and fast economic growth, rather than introduce drastic cooling measures.

Economists cited by Bloomberg think so too.

"The next steps for the central bank are to raise interest rates and allow the yuan to appreciate faster, possibly by widening the trading band," said Huang Haizhou, an economist at Barclays Capital in Hong Kong. "The tightening so far has done little to curb liquidity."...

"They will do more," said Dariusz Kowalczyk, chief investment strategist at CFC Seymour Ltd in Hong Kong. "Raising interest rates is more effective in cooling growth and I think they'll raise rates again in June."

US economy slows further

The news on the US economy yesterday was not good. GDP growth was down, consumer confidence was down, and inflation was up. Reuters sums it up.

Gross domestic product or GDP, which measures total goods and services output within U.S. borders, increased at a weaker-than-expected 1.3 percent annual rate in the three months from January through March...

The Reuters/University of Michigan Surveys of Consumers sentiment index showed a reading of 87.1, down from 88.4 in March and the lowest in seven months. It was the third straight monthly fall in the index but the final April reading was not as low as forecast...

The implicit deflator, one of several price measures within the GDP report, jumped at a four percent rate in the first quarter, more than double the prior quarter's 1.7 percent rate. It was the biggest rise in this gauge since the start of 1991.

A price gauge favored by the Federal Reserve -- personal consumption expenditures excluding food and energy items -- increased at a 2.2 percent rate in the first quarter, slightly ahead of forecasts for a 2.1 percent advance.

Businesses got a reprieve on employment costs though.

A second report, from the Labor Department, demonstrated corporate efforts to keep employee benefits damped, with overall employment costs rising a smaller-than-expected 0.8 percent in the first quarter.

That occurred despite a 1.1 percent gain in wages and salaries, the strongest since a 1.3 percent rise in the first quarter of 2001, as benefits costs edged up a scanty 0.1 percent, the least since a matching 0.1 percent rise in the first quarter of 1999.

However, most economists remain sanguine about the outlook. For example, Nigel Gault at Global Insight thinks that "the first quarter will prove to be the trough for growth".

Interest rates in Japan not looking likely to rise soon

The Bank of Japan looks unlikely to hike rates anytime soon. From Bloomberg:

The Bank of Japan slashed its inflation forecast close to zero and kept the benchmark interest rate unchanged, saying prices will take another year to accelerate.

Core consumer prices will rise 0.1 percent in the 12 months ending March 2008 and 0.5 percent the following year, the central bank said in Tokyo today in its semi-annual outlook. Policy makers had previously predicted a 0.5 percent inflation rate this year...

Core consumer prices, which exclude fresh food, declined 0.3 percent in March from a year earlier, the government statistics bureau said today, the second straight monthly drop.

Other government reports today showed factory output unexpectedly slumped 0.6 percent, retail sales declined for a sixth month, this time by 0.7 percent, and household spending rose a less-than-expected 0.1 percent. The unemployment rate held at a nine-year low of 4 percent.

Japan's manufacturing received a more mixed report from the purchasing managers index, reports Reuters.

The NTC Research/Nomura/JMMA Purchasing Managers Index, which gives an early snapshot of the health of manufacturing, declined to a seasonally adjusted 52.3 in April from 52.5 in March...

The PMI's new orders index, a barometer of future demand that combines goods orders from both home and abroad, stood at 50.8, the lowest level since January 2005...

However, the output index, which approximates industrial production, rose to 54.2 from 53.5 in March, marking the strongest growth since November.

But weakness in manufacturing has not been confined to Japan. Elsewhere in Asia, March manufacturing production was also down in South Korea and in Singapore.

US labour market cooling

MarketWatch reports the weekly initial jobless claims.

The Labor Department reported that weekly initial jobless claims fell by 20,000 to 321,000 in the week ending April 21. That's the lowest level in a month.

The four-week moving average of new claims, meanwhile, rose to its highest level since March 3, to 332,000...

The number of people collecting unemployment checks rose by 65,000 to 2.59 million in the week ending April 14, the most since Feb. 17. The four-week average of continuing claims rose by 19,250 to 2.53 million.

Meanwhile, the Conference Board reports that its Help-Wanted Advertising Index dipped one point in March to 30. It was 37 one year ago.

The Wall Street Journal's Greg Ip seems to think that the labour market is not cooling at a rate commensurate with that of the economy. In a recent article, he wrote:

When the Commerce Department publishes first-quarter growth estimates Friday, it will accentuate a puzzle with implications for interest rates, growth and U.S. living standards: With the economy growing so slowly, why is unemployment falling?

Explanations range from measurement problems to the peculiar behavior of construction jobs to the possibility that productivity growth is easing.

Barry Ritholtz at the Big Picture reads the article and suggests that either "Growth is better than reported, or Employment is worse than reported".

But before we go into possible explanations, let's take a look at a chart of the actual data.


From the above chart, it is not very obvious to me that there is anything amiss in the relationship between employment/unemployment level and GDP so far.

New Zealand hikes rates amid generally upbeat global economic data

New Zealand may be way down in the south, but its interest rates are way up in the north, especially after the latest rate hike today. Bloomberg reports:

New Zealand's central bank raised the benchmark interest rate to a record 7.75 percent, the second increase in seven weeks, because surging housing demand and consumer spending may fan inflation.

"The resurgence in economic activity that began in late 2006 has continued over recent months, with domestic demand continuing to expand strongly," Reserve Bank Governor Alan Bollard said in a statement released in Wellington today. "The lift in domestic demand is placing further pressure on already-stretched productive resources."

Bollard faces the dilemma of trying to cool domestic demand while limiting the damage to exporters, whose earnings have been eroded as higher interest rates caused the New Zealand dollar to surge to a 22-year high last week. He refrained today from commenting on the potential for further increases prompting some economists to speculate he's done raising rates for now.

New Zealand's trade gap did get a respite in March though.

New Zealand's annual trade deficit was little changed in March as higher prices for butter and milk powder buoyed exports more than expected, pacing demand for imported cars and machinery.

The merchandise trade shortfall was NZ$5.78 billion ($4.3 billion) in the year ended March 31 from NZ$5.77 billion in the 12 months ended February, Statistics New Zealand said today in Wellington. The median forecast of nine economists surveyed by Bloomberg News was for a NZ$5.85 billion gap.

On the opposite end of the world, Norway had left interest rates unchanged at 4.0 percent yesterday.

Meanwhile, mixed economic data in the US yesterday should add to the likelihood that the Federal Reserve stays on hold for a while more. Reuters reports that durable goods orders were up:

The Commerce Department said orders for long-lasting goods like new cars and refrigerators gained 3.4 percent to a seasonally adjusted $214.9 billion last month after a 2.4 percent February rise...

A key component of the monthly report that serves as a proxy for business investment, non-defense capital goods excluding aircraft, posted a 4.7 percent increase in orders last month.

But housing remains weak:

But a second department report showed sales of new homes rose 2.6 percent in March to an annual rate of 858,000 that was below forecasts for an 888,000-unit rate.

The inventory of completed but unsold homes gained slightly to 545,000 from 544,000 in February, a hefty overhang that analysts said will delay a recovery in the housing sector...

Other housing data on Wednesday was slightly more upbeat. A report from the Mortgage Bankers Association showed U.S. mortgage applications rose last week after five straight weekly declines, as lower loan rates fostered home purchases and refinancings.

And this probably summarises the overall state of the US economy:

...[T]he Federal Reserve's periodic Beige Book survey of national economic conditions during the period from the end of February to mid-April...said there was only "modest or moderate expansion in economic activity" and described manufacturing activity as slow.

Economic growth continues to be strong elsewhere, though.

South Korea grew four percent year-on-year in the first quarter and 0.9 percent from the fourth quarter of 2006 while the UK grew 2.8 percent in the first quarter or 0.7 percent on a quarterly basis.

And in Germany, the Ifo business confidence index rose to 108.6 in April, the second-highest level on record, from 107.7 in March, while the government raised its economic growth forecast for 2007 to 2.3 percent from 1.7 percent.

Interest rates unchanged in Canada, data weak in US, mixed in Europe

The Bank of Canada left interest rates unchanged yesterday. Reuters reports:

The Bank of Canada held its key lending rate unchanged at 4.25 percent on Tuesday and declined to hint at any rate rises ahead, even though it cautioned that inflation had sped higher than it had expected.

The Bank of Canada now sees inflation taking longer to return to the bank's 2 percent target, citing hikes in food and gasoline prices, and said the economy ran at just above its capacity in the first quarter of this year.

Yesterday also saw Statistics Canada report that Canada's composite leading indicator rose by 0.4 percent in March, driven by household spending and a robust labour market.

Things look a little less rosy a little to the south in the US. From Bloomberg:

Existing home sales slid 8.4 percent in March after rising 3.7 percent the previous month, the National Association of Realtors said today in Washington. A separate private report showed home-price declines in 20 major cities accelerated in February. The Conference Board's consumer confidence index fell to 104, from 108.2...

The supply of homes for sale decreased to 3.745 million last month. At the current sales rate, that represents a 7.3 months' supply, the highest since October. The median price of an existing home fell 0.3 percent last month from a year ago to $217,000.

Another industry report earlier today showed a measure of home values in 20 metropolitan areas, the S&P/Case-Shiller home-price index, declined 1 percent in February from a year earlier, the biggest price drop since the index started in 2001.

And meanwhile, manufacturing activity in the central Atlantic region continued to contract in April, according to the Richmond Fed’s latest survey.

The data from Europe were mixed. The National Bank of Belgium's business confidence indicator rose to 3.8 in April from 1.4 in March, but industrial new orders in the euro area fell 0.7 percent in February while in the UK, the Confederation of British Industry's manufacturing orders books balance fell to +2 in April from +8 in March. In Italy, retail sales rose 0.2 percent in February but consumer confidence fell in April after two consecutive months of rises.

UK inflation set to fall

That is according to a forecast in this FT report:

Inflation will fall back below the Bank of England's target after only one more rise in interest rates according to the latest forecast from the Ernst & Young Item Club.

Indeed, there were indications yesterday that past interest rate hikes are beginning to bite. From Reuters:

The British Bankers Association said underlying net mortgage lending rose by 5.1 billion pounds in March, the same as February's downwardly-revised figure, which was the weakest since April 2006...

Mortgage approvals figures from the Building Societies Association released at the same time also suggested demand may have peaked. Its data showed approvals for home loans totalled 4.830 billion pounds in March, the lowest since November...

BSA figures showed net mortgage lending reached its highest level in nearly 3-1/2 years in March, at 2.109 billion pounds.

The Council of Mortgage Lenders, meanwhile, said gross mortgage lending reached a record high for the month of March, at 31.260 billion pounds.

But unsecured lending fell by 200 million pounds in March, similar to the fall in February, the BBA said. Credit card lending accounted for half of this fall, with loans and overdrafts virtually unchanged, it said.

However, money supply growth picked up pace in March.

Provisional data showed M4 money supply rose 1.0 percent on the month -- its fastest increase since September. The annual rate held steady at 12.8 percent, wrongfooting many economists who had forecast a fall.

Stock markets move higher as interest rates stay low

Nothing seems to be able to keep global stock markets from rising ever upwards. Not US housing market woes, nor inflation concerns, nor Chinese overheating. And stock markets are likely to continue climbing higher as long as global interest rates stay low.

The Dow Jones Industrial Average added 2.8 percent last week to hit a new record of 12,961.98. The Standard & Poor's 500 Index rose 2.2 percent to 1,484.35, a six and a half year high and just three percent away from its all-time high of 1,527.46 attained on 24 March 2000.

In the process of achieving these gains, the US markets shrugged off a 4.7 percent fall in China's stock market on 19 April, the Dow actually hitting another record high on that day, and then following up with another one the very next day.

It was a similar story in Europe, where the Dow Jones STOXX 600 Index gained 1.6 percent last week to hit 389.26 while the Dow Jones Euro STOXX 50, an index for the countries sharing the euro, rose 2.3 percent to 3895.00.

Asian stocks also rose last week despite a region-wide tumble on 19 April set off by signs of overheating in China as the country released a report showing that the economy grew 11.1 percent in the first quarter and inflation accelerated to 3.3 percent in March. The Morgan Stanley Capital International Asia-Pacific Index added 0.8 percent last week, its third straight week of gains.

What is behind the resilience in global stock markets?

Better-than-expected earnings have helped. According to Bloomberg, about 66 percent of companies in the S&P 500 that have reported first-quarter results exceeded analysts' estimates. Projections for earnings growth in the first quarter for S&P 500 companies have improved to 6.2 percent from 3.1 percent a week ago.

Meanwhile, Europe and Asia have benefited from strong economic data, the negative reaction to China's growth notwithstanding. Mergers and acquisitions have also boosted markets, especially in Europe.

Ultimately, however, stock markets are being supported by low interest rates. Low interest rates not only support the real economic activity that provides the basis for stock valuations, they also fuel stock market buying directly and thus boost stock prices.


US interest rates have clearly been low and supportive of US stock markets. Long-term interest rates in the US have been drifting downwards since the middle of 2006 after the last interest rate hike by the Federal Reserve in July that year. In fact, the yield on the 10-year Treasury note, at about 4.7 percent, has practically drifted back to the level prevailing back in mid-2004 when the Federal Reserve started its tightening cycle, and is significantly lower than the earnings yield on the S&P 500 of about 5.5 percent.

Central banks in Europe and Japan are still in tightening mode, but with the Federal Reserve on the sidelines, do not seem to be making much of an impact on global interest rates on their own. In fact, the yields on 10-year government bonds in the euro area are still around where they were in the middle of last year despite five rate hikes by the European Central Bank since then.

In the meantime, the Bank of Japan's tightening has been very gradual -- only two rate hikes in the past year. As a result, Japanese interest rates remain low in absolute terms, helping to feed carry trades which, no doubt, are keeping interest rates elsewhere low as well.

Little wonder then that global stock markets remain buoyant. Investors know the old saying: Don't fight the Fed. But since the Fed is away, it is time for investors to come out and play.

But for how much longer? Investors have to be careful projecting low interest rates indefinitely. Although interest rates have generally merely fluctuated around current low levels over the past few years, they can sometimes sustain a trend in one direction long enough to have a disruptive impact on markets.

Remember that back in early 2005, rate hikes by the Federal Reserve were also failing to move longer-term interest rates up. However, towards the end of that year, yields on the 10-year Treasury note began to climb, eventually rising more than a percentage point and culminating in a sell-off in risky assets in May-June of 2006.

So the current bout of ECB and BoJ tightening could yet make a significant impact on markets.

And then, there is the fact that some economists are still thinking that the next move by the Federal Reserve is not a rate cut, as most other economists expect, but a rate hike. This could happen if inflation stays stubbornly high while the US economy recovers later in the year, as is widely expected. If the Federal Reserve does resume rate hikes, markets could see some interesting times indeed.

However, a rate hike by the Federal Reserve is an unlikely prospect for the time being -- not when the US economy is still in a soft patch. This means that stock markets are likely to stay resilient in the near future.

Consumers keep spending

The reliance of the global economy on the US consumer may be easing somewhat.

There was good news on the Japanese consumer this week. Consumer confidence rose to 46.8 last month from 45.9 in December. Meanwhile, demand for services as measured by the tertiary index climbed 1 percent in February following a revised 0.4 percent gain in January, helping to boost the all-industries index to a rise of 0.9 percent in February.

For the Japanese economy as a whole, though, the index of leading economic indicators for February has been revised down to 27.3 from an initial reading of 30.0, although a report from the central bank's regional branches said that Japan's economy is improving or expanding in all of the country's nine regions.

Meanwhile, consumer spending has also been robust elsewhere. French consumer spending on manufactured goods, for example rose, 0.7 percent in March.

UK retail sales did slow in March, though, rising 0.3 percent. But that followed a revised 1.6 percent gain in February, the strongest monthly gain in more than two years.

Rising pay is helping keep consumer spending up in the UK. Median British pay deals held at an 8-year high of 3.5 percent in the three months to March.

So does low interest rates, rate hikes notwithstanding. A study by Alliance and Leicester indicates that UK interest rates would need to rise to 8.5 percent for the cost of debt servicing as a proportion of national income to hit levels seen in 1990. So the BoE rate of 5.25 percent may not be such a big deal.

Dow hits new high amid sluggish US growth prospects

Unlike what happened two months ago, yesterday's stock market plunge in China had relatively little impact on markets in the US. Reuters reports:

U.S. stocks ended nearly flat on Thursday as a rally in health-care shares after earnings from companies such as Schering-Plough Corp. offset worries China may take steps that reduce demand for U.S. goods...

The Dow Jones industrial average rose 4.79 points, or 0.04 percent, to close at 12,808.63, a record. But the Standard & Poor's 500 Index was down 1.77 points, or 0.12 percent, at 1,470.73. And the Nasdaq Composite Index was down 5.15 points, or 0.21 percent, at 2,505.35...

Oil's drop, however, helped support the broader market. U.S. crude oil futures for May delivery slid $1.30 to settle at $61.83 a barrel as rising refinery production and the restart of a key pipeline eased worries of a U.S. fuel supply crunch.

Meanwhile, economic reports yesterday point to continuing slow growth ahead for the US economy. Again from Reuters:

The Philadelphia Federal Reserve Bank said on Thursday its business activity index was at 0.2 in April, sharply below economists' forecasts for a reading of 2.0.

The index was at 0.2 in March...

Further evidence of slowing economic growth was provided by the New York-based Conference Board, which said the U.S. Composite Index of Leading Economic Indicators rose 0.1 percent in March, as expected, after declining 0.6 percent in February and 0.3 percent in January...

Initial filings for state unemployment insurance aid fell to 339,000 in the week ended April 14 from a slightly upwardly revised 343,000 for the previous week, the U.S. Labor Department said. Economists had expected a far larger decline.

China's GDP surges, stock markets plunge

Good news is bad news again.

AFP/CNA reports the latest growth figures from China.

China's economy picked up speed in the first quarter, growing 11.1 percent compared with the same period a year earlier, the government said Thursday...

The three months to March posted the highest quarterly growth rate since the second quarter of last year, when the economy expanded 11.5 percent, according to revised government data.

Announcing the figures, the National Bureau of Statistics noted a whole series of concerns about the pace of economic growth which continues to run ahead despite government efforts to put the country on a more sustainable path.

"Outstanding problems existing in economic development are an imbalanced balance of payments, excessive liquidity, an irrational economic structure and high pressure on energy conservation and pollutant emissions reduction," NBS spokesman Li Xiaochao said in a statement.

China's main measure of inflation, the consumer price index, rose 2.7 percent in the first quarter of 2007 from a year earlier, the NBS said.

CPI in March alone was up 3.3 percent, suggesting a pick up in price pressures.

Chinese premier Wen Jiabao chimed in with warnings about overheating.

Chinese Premier Wen Jiabao called for steps to prevent fast growth from leading to an overheated economy, the government said Thursday, as first quarter GDP increased by 11.1 percent.

"We must...prevent the economy from changing from rather fast paced (growth) to overheated, while also avoiding large ups and downs," the government quoted Wen as telling a Wednesday cabinet meeting.

Earlier in the day, Asian markets had already seen this coming. From Bloomberg:

Asian stocks fell the most in a month as Chinese reports showing faster-than-expected economic growth and inflation fueled concern interest rates will rise in the region's second-largest economy. China Mobile Ltd. dropped...

The Morgan Stanley Capital International Asia-Pacific Index lost 1.4 percent to 147.22 as of 6:20 p.m. in Tokyo. The measure yesterday climbed to a record 149.27, completing its recovery from a global rout that was sparked Feb. 27 by the steepest plunge in China's stocks in a decade.

Japan's Nikkei 225 Stock Average lost 1.7 percent and China's CSI 300 Index plunged 4.7 percent, the most since the rout began, after closing yesterday at a new high. All of the region's markets declined.

Currency movements did not help.

A weaker dollar also weighed on Asian exporters including Canon Inc. and Samsung Electronics Co., while lower metals prices contributed to slides in BHP Billiton Ltd. and Rio Tinto Group...

The yen reached 117.61 per dollar today, the strongest since April 3. The won rose as much as 0.2 percent to 926.10, the strongest since Jan. 3, according to Seoul Money Brokerage Services Ltd...

Data point to continued growth in Germany and rate hikes in UK

The Conference Board's leading index for Germany points towards further growth for the economy.

The Conference Board announced today that the leading index for Germany increased 0.8 percent and the coincident index increased 0.3 percent in February... Based on revised data, this index increased 0.2 percent in January and increased 0.2 percent in December. During the six-month span through February, the leading index increased 0.3 percent, with four of the eight components increasing (diffusion index, six-month span equals 57.1 percent).

The latest ZEW indicator released on Tuesday is pointing in the same direction.

The recovery of the ZEW Indicator of Economic Sentiment for Germany gained momentum in April 2007. The indicator rose by 10.7 points and now stands at 16.5 points after 5.8 points in March. This is still far below its historical average of 33.1 points.

The euro zone is expected to do well too.

Economic expectations for the euro zone have increased as well. The indicator rose by 5.6 points and now stands at 10.7 points...

These indicators add weight to the view that the European Central Bank will be raising rates soon.

However, for the moment, the focus appears to be more on the Bank of England. From Reuters:

Wages rose at their fastest rate in almost three years in February, reinforcing expectations interest rates will rise not only next month but again after that.

And minutes of the Bank of England's April meeting showed policymakers were worried about price pressures even before news of last month's surge in inflation that forced Bank Governor Mervyn King to explain himself to the government.

Consumer price inflation rose to 3.1 percent last month, its highest since comparable records began a decade ago. Retail price inflation, on which most pay deals are based, hit its highest in nearly 16 years, meaning wage pressures are likely to increase.

That is putting strong upward pressure on sterling.

Sterling surged to its highest level in more than a quarter of a century above US$2.01 on Wednesday as strong pay numbers bolstered expectations that interest rates are set to rise further.

Looking beyond the core, inflation remains elevated

The Federal Reserve has been expecting inflation in the United States to moderate for some time. At first sight, yesterday's report on consumer prices appears to confirm that expectation. However, the underlying inflation trend may not be so favourable.

Many analysts looking at yesterday's inflation report from the Labor Department focused on core consumer prices excluding food and energy, and by that measure, the inflation trend looks good. Core prices rose only 0.1 percent in March, showing a moderation after gains of 0.2 percent in February and 0.3 percent in January.

However, by other measures, the inflation trend looks less benign. The overall consumer price index was up 0.6 percent, showing an acceleration after gains of 0.4 percent in February and 0.2 percent in January. Energy costs were the main driver in the overall rise in consumer prices in March, with gasoline prices jumping 10.6 percent.

Removing the volatile components of the CPI does little to improve the apparent inflation trend. The 16-percent trimmed mean CPI and the median CPI monitored by the Federal Reserve Bank of Cleveland both rose by 0.3 percent in March, about the same rate as in recent months.

The following table from the Cleveland Fed shows the recent monthly percentage changes in all these indicators.

	Oct	Nov	Dec	Jan	Feb	Mar
CPI	-0.4	0.0	0.4	0.2	0.4	0.6
CPI less food & energy	0.1	0.1	0.1	0.3	0.2	0.1
16% trimmed-mean CPI	0.1	0.1	0.2	0.3	0.3	0.3
Median CPI	0.3	0.2	0.3	0.2	0.3	0.3

The next table, showing the percentage changes in these indicators over the last 12 months, makes it even clearer that inflation remains elevated and is not likely to fall to the Federal Reserve's comfort level of 2 percent any time soon.

	Oct	Nov	Dec	Jan	Feb	Mar
CPI	1.3	2.0	2.5	2.1	2.4	2.8
CPI less food & energy	2.7	2.6	2.6	2.7	2.7	2.5
16% trimmed-mean CPI	2.7	2.6	2.7	2.6	2.8	2.8
Median CPI	3.5	3.6	3.6	3.6	3.6	3.5

Yesterday, the Federal Reserve released a report on industrial production that also suggests that there will be little relief in inflationary pressures from this front. Industrial production fell 0.2 percent in March but manufacturing output increased 0.7 percent. Total industry capacity utilisation is at 81.4 percent while manufacturing capacity utilisation is at 80.1 percent. Both are within about one percentage point of cycle peaks and, indeed, have stayed relatively stable over the past six months.

And with the Federal Reserve also reporting last week that growth in money supply as measured by M2 accelerated to an 8.4-percent annual rate in the three months to March, perhaps we should not write off the possibility that inflation may even accelerate some time in the not-too-distant future.

The Federal Reserve is not the only central bank concerned about inflation.

Yesterday also saw the Office for National Statistics report that the consumer price inflation rate in the United Kingdom hit 3.1 percent in March, well above the Bank of England's target of 2 percent and forcing BoE governor Mervyn King to write a letter of explanation to the Chancellor of the Exchequer. Another rate hike by the BoE in May is now expected by most economists.

On Monday, Eurostat reported that consumer prices in the euro area increased 1.9 percent from a year earlier in March, up from a 1.8-percent rise in February. On a monthly basis, prices in March were up 0.7 percent from the previous month, the fastest rate of increase in almost a year. This was despite consumer prices in Germany rising by only 0.2 percent in March, although even in Germany the annual inflation rate edged up to 2.0 percent in March from 1.9 percent in February.

So there is good reason to remain concerned about inflation worldwide, as even the International Monetary Fund acknowledges. In its latest World Economic Outlook report, the IMF said that inflation pressures in the advanced economies have "generally eased" but "concerns do remain". Some factors it cited for the concerns include slowing productivity growth in the US and low unemployment and high capacity utilisation rates in the euro area.

The IMF also noted that real interest rates are "generally below long-term averages". Indeed, according to Bloomberg, yields on 10-year government notes yesterday were at about 4.7 percent in the US, 5.1 percent in the UK and 4.2 percent in Germany. Based on the latest 12-month inflation rates, real interest rates are only around 2 percent.

It remains to be seen how long such low real interest rates will take to tame inflation.

Stocks surge in the face of mixed data

Bloomberg reports the strong gains made by US stock markets yesterday, putting the February-March sell-off behind them.

The S&P 500 added 15.62, or 1.1 percent, to 1468.47, its highest since September 2000. All 10 industry groups advanced today, bringing the benchmark's gain in April to 3.4 percent.

The Dow industrials rose 108.33, or 0.9 percent, to 12,720.46. The 30-stock gauge is 0.5 percent shy of matching its record close set Feb. 20. The Nasdaq Composite Index increased 26.39, or 1.1 percent, to 2518.33, its highest since Feb. 22.

It was a similar story for Europe and for Asia earlier in the day.

The economic reports yesterday were only mixed though. US retail sales increased 0.7 percent in March and February sales were revised higher to a 0.5 percent gain from 0.1 percent previously reported but the housing market remains in the doldrums, with the Wells Fargo/NAHB housing-market index falling from 36 in March to 33 in April, the lowest level since December.

Earlier yesterday, Japan reported that its industrial output for February had been revised to a gain of 0.7 percent from an initial estimate of a decline of 0.2 percent.

Meanwhile, Europe has inflation concerns again. Inflation in the euro area accelerated in March to 1.9 percent from 1.8 percent in February while the UK faces an acceleration in producer prices and house prices.

US trade deficit falls, inflation data mixed

The US trade deficit was down in February, but mostly due to a fall in imports as exports also fell. Reuters reports:

The February trade gap fell to $58.4 billion, as crude oil imports fell sharply to the smallest in four years and average imported oil prices were the lowest since December 2005, a government report showed...

Overall U.S. imports fell 1.7 percent in February to $182.4 billion...

Overall U.S. exports retreated 2.2 percent to $124.0 billion...

Meanwhile, consumer sentiment continues to slide even as inflation expectations are rising.

The Reuters/University of Michigan Surveys of Consumers said the preliminary April reading of its consumer sentiment index slid to 85.3 from 88.4 in March.

The April result was the lowest since 82.0 in August 2006 and marked the third straight fall in the index...

The sentiment survey also showed its one-year inflation index popping to 3.3 percent in April after holding steady for three months at 3.0 percent.

But wholesale price inflation in March was mostly concentrated in energy.

Rising energy prices boosted overall producer prices in March by a greater-than-expected 1 percent, a Labor Department report showed. But without food and energy, prices on the producer level were flat that month.

Asha Bangalore at Northern Trust analysed yesterday's data and had the following to say:

To the extent that core wholesale prices are contained and core intermediate goods prices are moderating, the threat of troubling inflation is not significant. But, the upward trend of energy and food prices and the impact of a pass-through of higher energy prices present a risk...

The trade deficit improved slightly in nominal terms in February... However, after adjusting for inflation the trade deficit of goods widened in February to $57.3 billion from $56.9 billion in the prior month. Effectively, the January-February inflation adjusted trade deficit for goods is wider than the average for the fourth quarter, implying that trade gap is likely to be a drag on GDP growth in the first quarter.

The 3.7% drop in inflation-adjusted exports is bothersome...

And Calculated Risk reminds us:

Also notice the prior time period when the trade deficit declined slightly... right before the recession of 2001.

Meanwhile, in the euro zone, the ECB may have left interest rates unchanged on Thursday but the central bank remains committed to further rate hikes. Reuters reports:

European Central Bank Governing Council Member Yves Mersch said on Friday the euro zone faces risks from inflation and the process of raising interest rates was not yet complete...

In remarks a day after the ECB left rates unchanged at 3.75 percent, but cemented expectations it would hike to 4 percent in June, Mersch also stressed euro-zone growth could weather a slowdown in the United States, while inflation was a worry.

Recent economic data in the euro zone have been encouraging, with fourth quarter GDP growth being confirmed at 0.9 percent and industrial production in February rising 0.6 percent.

Chinese money supply, forex reserves surge

China's authorities have been talking about tightening policy. They probably need to step up the pace. From Bloomberg:

China's money supply grew by more than the central bank's target for a second month and foreign- exchange reserves surged to a record $1.2 trillion, increasing pressure on the government to allow faster yuan gains.

M2, which includes cash and all deposits, increased 17.3 percent in March from a year earlier, the central bank said today. The currency reserves, the world's largest, grew 37 percent from a year earlier, the fastest pace since November 2005.

Booming exports helped drive a $136 billion increase in the reserves in the first quarter...

Faster yuan appreciation is "an essential tool to tighten overall monetary conditions," JPMorgan Chase & Co. economist Wang Qian said in Hong Kong.

The increase in reserves led Macro Man to ask: "What the hell is China playing at?".

What makes the reserve growth particularly galling is that the authorities have dramatically slowed the pace of RMB appreciation since mid February. Now, maybe this has been in preparation for a large one-off step revaluation of the RMB....but probably not.

Even without a revaluation, China is no longer exporting deflation to the same extent that it once did, not to the US anyway. Again from Bloomberg:

Prices of U.S. imports rose last month by the most in almost a year, led by gains in crude oil and natural gas that are likely to keep the Federal Reserve from cutting interest rates.

The 1.7 percent increase was more than twice economists' forecasts and followed a 0.1 percent gain in February, the Labor Department said in Washington today. Prices excluding petroleum rose 0.3 percent. Separate numbers from the department showed jobless claims climbed last week...

Today's report showed prices for imported consumer goods excluding autos rose 0.2 percent after no change in the prior month. They increased 1.8 percent from the same month last year, the biggest year-over-year rise since January 1996. Prices of imported automobiles, parts and engines rose 0.1 percent after rising 0.2 percent...

Prices of goods from China rose 0.2 percent in March. Prices of U.S. exports rose 0.7 percent in March after rising 0.7 percent. Prices of farm exports increased 2.1 percent, while those of non-farm exports rose 0.6 percent.

Mike Larson makes a similar observation at Interest Rate Roundup.

UK economy looking robust

Reuters reports that retail sales were strong in March.

The British Retail Consortium/KPMG retail sales monitor said the value of like-for-like sales grew an annual 3.9 percent last month, accelerating from 3.3 percent in February and the highest since April 2006.

Total sales, which include new floorspace, grew 6.2 percent on a year ago, up from 5.6 percent in February and paced by shoppers' demand for food, clothing and home improvement goods.

House prices continue to rise.

The Royal Institution of Chartered Surveyors said its house price balance rose to +25.5 in the three months to March from +24.8 in February, confounding analysts' forecasts for a reading of +20.

And the Conference Board's leading index for the UK points to continued economic growth.

The Conference Board announced today that the leading index for the U.K increased 0.8 percent, and the coincident index increased 0.2 percent in February... Based on revised data, this index increased 0.3 percent in January and increased 0.1 percent in December. During the six-month span through February, the leading index increased 1.8 percent, with six of the eight components advancing (diffusion index, six-month span equals 68.8 percent).

Thailand cuts interest rate

Thailand's interest rates are headed lower. From Bloomberg today:

Thailand's central bank cut its key interest rate for a third time this year and signaled borrowing costs may be lowered further to spur a slowing economy as confidence slides and anti-government protests mount.

The Bank of Thailand lowered its one-day bond repurchase rate to 4 percent from 4.5 percent. The decision was expected by 10 of 16 economists surveyed by Bloomberg News.

"Monetary policy could be eased further at an accelerated pace to support economic growth," Suchada Kirakul, a Bank of Thailand assistant governor, told reporters at press briefing. "Weak private sector confidence will dampen domestic spending. The interest rate is still on an easing trend."

Not everyone is convinced the rate cut will help.

"It's hard to see how an interest rate cut can have much of an impact on consumer spending and investment," said George Worthington, an economist at Thomson IFR in Sydney, who predicted the 50 basis point reduction. "Political uncertainty is having a major impact on confidence, so until that is sorted out the central bank's moves may only have a limited effect."

Well, if it doesn't work, they can always change policy. We know the Thai authorities are flexible.

Elsewhere in Asia, the Monetary Authority of Singapore yesterday said it was keeping its exchange rate policy unchanged. From CNA:

"While domestic cost pressures have emerged in some segments of the economy, they remain relatively contained and overall inflationary pressures are expected to stay low," the MAS said in its bi-annual policy statement on Tuesday.

"The MAS will maintain the policy of a modest and gradual appreciation of the Singapore dollar...in the period ahead. There will be no re-centring of the policy band, or any change to its slope or width."

This came as the Singapore government reported 6 percent first quarter GDP growth compared to the same period last year, or 7.2 percent on an annualised quarter-on-quarter basis.

Meanwhile, Japan looks likely to continue to tighten only very gradually after reporting that machinery orders fell in February. Bloomberg reports:

Japan's machinery orders fell a more-than-expected 5.2 percent in February, highlighting concern among manufacturers that export growth may slow this year...

Orders for electronic machinery such as semiconductor testing equipment led the declines, falling 29.7 percent, the biggest drop in almost nine years.

In other news from Japan, its current account surplus rose 4.9 percent in February as exports rose 9 percent and imports climbed 10.3 percent while money supply measured by M2 plus certificates of deposit rose 1.1 percent year-on-year.

Japanese interest rates unchanged, Chinese trade surplus plunges

The Bank of Japan kept interest rates unchanged today. Bloomberg reports:

Governor Toshihiko Fukui and his policy board colleagues voted unanimously to hold the key overnight lending rate at 0.5 percent, the lowest among major economies, the bank said in a statement today in Tokyo. The decision was expected by all 49 economists surveyed by Bloomberg News.

Fukui later told reporters that the U.S. economy will achieve a soft landing and Japan's consumer prices will rise in the long run after hovering around zero percent in coming months...

Demand may be picking up at home, too. Spending among Japanese households rose in the first two months of 2007 after declining every month last year. Economic and Fiscal Policy Minister Hiroko Ota told reporters today that consumption is showing "brighter signs," though wages need to increase more.

No excitement there. Developments next door were a little more interesting. Again from Bloomberg:

[China's March trade surplus] was $6.87 billion... 38 percent smaller than a year earlier, the least in 13 months, and below the $20 billion median estimate of a Bloomberg survey of economists...

Exports gained 6.9 percent to $83.4 billion in March, the slowest pace in five years, and imports climbed 14.5 percent to $76.6 billion.

The reason for the plunge?

Chinese businesses rushed to sell products overseas in January and February in anticipation of government measures to slow exports and because of protectionist sentiment abroad, said Wang Qing, an economist at Bank of America Corp. in Hong Kong.

Good Friday employment data could resurrect inflation concerns

Last week, the data on the United States economy culminating in the good Friday employment report show that the economy remains alive and well. The same, though, could be said of inflation.

The US housing sector has been among the hardest hit in the economy thus far but last week saw some better news for it. The National Association of Realtors' index of pending sales of existing homes rose 0.7 percent. It was still down 8.5 percent from the previous year, though, and with the fallout from the subprime mortgage market still spreading, it still looks like the housing sector will take a while more to stabilise, much less recover.

Last week's reports from the Institute for Supply Management confirm that the economy is still slowing but not near recession levels. The PMI, the ISM's composite manufacturing index, fell to 50.9 in March from 52.3 in February while the ISM's non-manufacturing index fell to 52.4 in March from 54.3 in February.

Meanwhile, the ISM reports show that inflation remains a concern. For manufacturing, the sub-index of prices rose to 65.5 from 59.0 in March while for non-manufacturing, the prices sub-index jumped to 63.3 in March from 53.8 in February.

Friday's employment report showed that the US economy added 180,000 jobs in March. This leaves the average monthly job gain for the first quarter at 152,912, a respectable figure for this stage of the economic cycle.

Indices of leading indicators have been weakening recently but are not pointing to a recession yet. The Organisation for Economic Co-operation and Development last week reported that its composite leading indicator for the US economy decreased by 0.3 point in February. The Economic Cycle Research Institute reported that its weekly leading index inched down to 140.3 in the week to March 30 from 140.5 in the prior week but still showed an annualised growth rate of 3.9 percent.

Indeed, in an interview with Bloomberg Television, Lakshman Achuthan, managing director of the ECRI, said that the latest employment data could be confirming that "the economy is turning".

That would be good news for growth but bad news for inflation. As it is, the major indicators of inflationary pressures in the US economy monitored by the Federal Reserve are still not moving in the right direction. Core inflation in February as measured by the year-on-year change in the personal consumption expenditure price index excluding food and energy was 2.4 percent, practically back at its recent high. The employment report showed that average hourly earnings in March were up 4.0 percent, near its cycle high, while the unemployment rate was at 4.4 percent, revisiting its cycle low.


As I said last week, inflation remains elevated and could take a while to abate. The fixed income market must be thinking the same; the yield on the 10-year Treasury note, which had fallen to around 4.5 percent in early March, is now back up to 4.75 percent.

Nevertheless, this still leaves the real yield at just over 2 percent, not high by historical standards. In fact, it is barely at the recent, below-trend real GDP growth rate.

That should help keep the economy afloat, but at the cost of sustained inflation pressures.

Strong US job report but economy could still slow, as could Japan's

If the US economy is slowing, it is not showing up in the March employment report. From Bloomberg:

American employers added more workers than forecast in March and the jobless rate matched a five-year low, giving the economy a spark as it struggles to overcome slumps in housing and manufacturing.

The 180,000 increase in employment, the most in three months, followed a 113,000 gain in February that was larger than previously estimated, the Labor Department reported today in Washington. The jobless rate fell to 4.4 percent, a level last seen in October, defying predictions it would climb...

Revisions for the prior two months showed employers added 32,000 more jobs than earlier estimated.

Workers' average hourly earnings rose 6 cents, or 0.3 percent, after a 0.4 percent increase the previous month... Earnings were up 4 percent from March last year.

There was more good news.

Separately, the Commerce Department reported that sales at U.S. wholesalers outpaced inventories in February, which may lay the groundwork for a manufacturing rebound in coming months.

The 1.2 percent increase in sales followed a 0.9 percent decline a month earlier. Stockpiles of unsold goods rose 0.5 percent. Wholesalers make up about a quarter of all business inventories...

Meanwhile, Reuters reports that consumer credit growth slowed in February.

U.S. consumer credit rose $2.97 billion in February on a pick-up in credit card usage, which made up for a sharp slowdown in growth of closed-end consumer loans for cars, holidays and other big-ticket items, a Federal Reserve report showed on Friday.

Consumer credit rose at a 1.5 percent annual rate in February to $2.410 trillion, following an upwardly revised January increase of 3.3 percent, or $6.61 billion.

Nevertheless, the strong job report points to sustained inflation pressures, as does the Economic Cycle Research Institute's inflation gauge, as Reuters reports:

The Economic Cycle Research Institute's U.S. Future Inflation Gauge, which is designed to anticipate cyclical swings in the rate of inflation, rose to 118.6 in March from 118.5 in February, revised down from 118.7.

On the other hand, the ECRI's leading indicator eased last week.

The Economic Cycle Research Institute, an independent forecasting group, said its Weekly Leading Index inched down to 140.3 in the week to March 30 from a revised 140.5 in the prior week.

That is in line with other forecasts. From Reuters:

The International Monetary Fund has revised down its forecast for U.S. economic growth by 0.4 percentage points, a German newspaper reported in its online edition on Friday.

A report from the Organisation for Economic Cooperation and Development also pointed to a slowdown in the world's largest economy, and signaled a weaker outlook for G7 economies as a whole...

In a report released in Paris, the OECD said its composite leading indicator (CLI) for the United States declined to 106.1 in February from 106.4 the previous month.

"February 2007 data show weakening performance in the CLI's six month rate of change in most of the major seven economies (G7)," the OECD said.

However, the CLI figure for the 30-nation OECD area came in at 109.5, unchanged from January.

Japan may also not be able to escape a slowdown. Reuters reports:

Japan's diffusion index of leading indicators, a barometer of the economy, dipped below a key threshold in February for the fourth straight month, casting doubt over the strength of the economic recovery.

The government also downgraded its view on the current state of the economy for the first time in nearly two years, saying underlying economic conditions are weakening and warrant close monitoring.

The leading index, which gauges conditions several months ahead, fell to a preliminary 30.0 in February from 40.9 in January, government data showed on Friday.

BoE holds, PBC tightens

The Bank of England left interest rates unchanged yesterday. FT reports the decision and yesterday's UK economic data:

The cost of borrowing remained at 5.25 per cent on Thursday but a large majority of economists expect the Bank of England to deliver another increase in May.

The Bank’s decision not to change its main interest rate followed evidence that industrial growth is slowing and the housing market may be losing some of its vigour – and it suggests the Bank is prepared to wait and see whether the three previous increases since August have cooled demand...

The view that the Bank’s monetary policy committee would stay its hand this month had gained ground on Thursday morning after the Office for National Statistics said UK manufacturing output contracted unexpectedly in February.

The 0.6 per cent fall in output between January and February was the second month in a row the sector had shrunk and marked the biggest decline since October 2005.

After adding the mining and utility sectors, industrial production as a whole fell by 0.2 per cent month-on-month, a much weaker performance than analysts had forecast...

The Halifax said on Thursday that house prices rose by 1 per cent in March but that the the first three months of the year saw prices climb by 2.8 per cent compared to 4.2 per cent in the fourth quarter of 2006.

On the other hand, German industrial production rose 0.9 percent in February.

But if any cooling measures are needed, it is probably in Asia, and China delivered another one yesterday. From AFP/CNA:

China's central bank on Thursday ordered major commercial banks to set aside more money in reserves in an effort to slow its economy, the third of such cooling measure of 2007.

The People's Bank of China said in a statement the action was designed to enhance bank liquidity management and prevent excessively fast credit growth.

It said the required deposit reserve ratio for most commercial lenders would rise on April 16 by 0.5 percentage point to 10.5 percent.

The Indian authorities may have to do something soon too. From another AFP/CNA report:

India's inflation rate eased slightly to 6.39 percent, according to official data on Thursday, but remained far above the central bank's tolerance level.

The inflation rate fell to 6.39 percent for the week ended March 24 on the back of a fall in some food prices from 6.46 percent where it had been stuck for the previous three weeks, figures showed.

More of the same

There was more evidence of a slowing US economy yesterday. Reuters reports:

The Institute for Supply Management said its non-manufacturing index slid to 52.4 in March, down from February's 54.3 and confounding expectations for a rise.

Despite the weak result, which came in below even the lowest of 85 estimates in a Reuters survey, the ISM's inflation gauged jumped.

Meanwhile, U.S. private employers likely added 106,000 jobs in March, according to a report by ADP Employer Services. The March figure was higher than February's 57,000 gain but below markets' expectations...

The Commerce Department reported that new orders at U.S. factories rose just 1 percent in February, below expectations for a 1.8 percent rise.

A January drop in factory orders was revised downward to the biggest decline in more than six years. Orders for durable goods, items meant to last three years or more, rose 1.7 percent in February, also revised down from last week.

However, there was some positive economic news. Planned U.S. job layoffs fell 42 percent to an eight-month low in March from February, Challenger, Gray & Christmas, Inc., the global outplacement consultants, said. But the outlook remained bleak in the troubled housing market, the company said.

Europe's economy looks better. From Bloomberg:

European service industries from banking to airlines expanded in March at close to the fastest pace in six months after unemployment declined and economists raised forecasts for growth.

Royal Bank of Scotland Group Plc's services index slipped to 57.4 from 57.5 in February. That compares with 57.9 in January, the highest since July. The index is based on a survey of purchasing managers by NTC Economics Ltd. and a reading above 50 indicates expansion. Economists expected the gauge to stay unchanged at 57.5, according to the median estimate of 32 analysts surveyed by Bloomberg News...

An increase in value-added tax in Germany and higher income tax in Italy have also curbed household spending in Europe. Euro region retail sales fell 0.8 percent in January and rebounded just 0.3 percent in February, the European Union's statistics agency Eurostat said today. The Italian services index fell to 54.1 last month, its lowest level since November.

And German factory orders jumped in February.

Orders, adjusted for seasonal swings and inflation, increased 3.9 percent from January, when they declined 0.3 percent, the Economy and Technology Ministry said today. Economists expected a gain of 0.5 percent, the median of 38 estimates in a Bloomberg News survey showed.

Meanwhile, the UK services accelerated last month. From Bloomberg:

An index based on replies from about 700 service companies, excluding retailers, showed a reading of 57.6, up from 57.4 in January, the Chartered Institute of Purchasing and Supply and Royal Bank of Scotland Group Plc said today. Economists expected 57.5, the median of 34 estimates in a Bloomberg survey showed.

As did shop prices, the British Retail Consortium's shop price index increasing 0.49 percent in March, up from 0.29 percent in February, mainly on higher food prices.

Despite the relatively weak US data, US stock prices were up yesterday. Bloomberg reports:

U.S. technology shares sent the Dow Jones Industrial Average and Nasdaq Composite Index to their fifth consecutive gain on an improved profit forecast for Microsoft Corp...

The Dow industrials added 19.75, or 0.2 percent, to 12,530.05. The Nasdaq rose 8.36, or 0.3 percent, to 2458.69. The S&P 500 increased 1.60, or 0.1 percent, to 1439.37.

Emerging markets did even better.

... The Morgan Stanley Capital International Emerging Markets Index climbed 1.2 percent to 948.03, eclipsing a record of 943.88 set three days before a sell-off in China sparked $3.3 trillion in equity losses worldwide. Indexes in South Korea, China, Indonesia, Peru, Mexico, the Czech Republic and Poland climbed to all-time highs.

Lower oil prices helped.

Crude fell in New York after Iran's President Mahmoud Ahmadinejad said that he will release 15 seized Britons, easing concern of a conflict in the Persian Gulf. Prices pared losses after an Energy Department report showed that U.S. gasoline supplies plunged for an eighth week.

Oil for May delivery fell 26 cents, or 0.4 percent, to settle at $64.38 a barrel on the New York Mercantile Exchange...

In other markets, U.S. Treasuries rose after the weaker- than-forecast economic reports, pushing benchmark 10-year note yields down from a one-month high...

Copper prices in New York gained for the sixth session in a row, the longest rally since September, on signals that mine development will lag behind demand from China and other countries with surging economies.

So we have a slowing US economy but a resilient European economy, prices/markets rising (even oil kept much of its recent gains) and interest rates low. In other words, more of the same.

Japan's monetary base falls, Australia leaves rates unchanged

Japan's monetary base shrank 19.1 percent in the year to March 2007. Someday, this trend will end the yen carry trade. But not now. From Bloomberg:

The yen traded near the lowest in five weeks against the dollar as traders borrowed cheaply in Japan to invest in U.S. and European stocks.

Japan's currency has dropped against 69 of 71 currencies tracked by Bloomberg in the past week on speculation the nation's interest rates will stay the lowest among major economies, encouraging so-called carry trades. Gains in stocks give investors more confidence to put on trades with borrowed money.

"Its game back on for the carry trade," said Jonathan Cavenagh, a currency strategist at Westpac Banking Corp. in Sydney. "I expect to see further weakness in the yen."

It's all about central banks, I guess, and this news should limit the downside for the yen, at least for a while.

Australia's central bank kept its benchmark interest rate unchanged at a six-year high, giving policy makers time to study an inflation report later this month that economists say may prompt an increase.

The nation's currency dropped by the most in a month after Reserve Bank of Australia Governor Glenn Stevens left the overnight cash rate target at 6.25 percent for a fourth straight meeting. Thirteen of 25 economists surveyed by Bloomberg News predicted no change today.

However, the RBA could still raise rates soon, unlike the Federal Reserve, whose bias might nevertheless have been hardened somewhat by yesterday's housing data, reported by Bloomberg.

More Americans signed contracts to buy previously owned homes in February, easing concern the real-estate market will get even worse.

The National Association of Realtors' index of signed purchase agreements rose 0.7 percent after dropping 4.2 percent in January. Economists had forecast a decline. The index was down 8.5 percent from a year earlier.

The European Central Bank could also raise rates soon, especially after producer prices rose 0.3 percent in February, faster than January's 0.2 percent.

But some think the Bank of England will be the next to hike rates on Thursday, especially as wage growth and consumer confidence appear to be firm in March. From Reuters:

Eleven out of 60 analysts polled by Reuters last month predicted the BoE would hike a fourth time and take borrowing costs up to 5.5 percent this month. The rest saw no change but assigned a high probability to another rise. And if they don't this month, they will in May, seems to be the conventional wisdom.

Japanese business confidence, global manufacturing PMI fall

AFP/CNA reports the Tankan survey findings for the first quarter.

Business confidence among Japan's major manufacturers fell back from a two-year high over the three months to March, marking the first decline for one year, the central bank reported Monday.

Confidence among Japan's big manufacturers dropped to 23 in March from 25 in December, the Bank of Japan's quarterly Tankan survey showed, slightly below market expectations for a figure of 24...

On a brighter note, sentiment among major non-manufacturers held steady at 22 in December, defying market expectations of a decline to 20.

The big manufacturers forecast a further drop in confidence to 20 by June while the large non-manufacturers expect a pick-up to 23...

The Tankan survey of almost 10,000 firms showed that all companies expect to trim capital expenditure by 0.3 percent on average in the current fiscal year to March 2008, after a 9.5 percent rise last year.

Reuters reports the global PMI for March.

Global manufacturing growth eased in March across all major industrial regions, but price pressures remain, a report showed on Monday.

The Global Manufacturing indicator, produced by JP Morgan with research and supply management organisations, eased to 52.9 in March from 53.7, but still held above the 50.0 mark dividing growth from contraction.

Bloomberg has the details on the US data:

Manufacturing growth in the U.S. slowed more than forecast last month and raw-materials costs jumped, reinforcing concerns that a cooling economy isn't reducing inflation.

The Institute for Supply Management said today its factory index fell to 50.9, from 52.3 in February. The median estimate of economists surveyed by Bloomberg News was for a drop to 51.4. A sub-index of prices rose the most in seven months, while measures of employment and new orders declined.

And the eurozone data:

Europe's manufacturing growth unexpectedly slowed in March after demand for exports cooled and a tax increase in Germany reduced consumer spending in the region's largest economy.

Royal Bank of Scotland Group Plc said its index of manufacturing in the euro region fell to 55.4, the lowest since February 2006, from 55.6 a month earlier. A reading above 50 indicates growth. Economists expected the gauge, compiled by NTC Economics Ltd. from a survey of 3,000 purchasing managers, to increase to 55.7, the median of 32 estimates in a Bloomberg News survey showed.

AFX/Forbes reports the Chinese data in the form of the CLSA PMI:

The China Purchasing Managers' Index (PMI) fell to 52.3 in March from 53.0 in February, even though the manufacturing sector continued to improve, CLSA said.

... as well as the CFLP PMI:

The purchasing manager's index (PMI) for the manufacturing sector rose to 56.1 points in March from 53.1 in February, the China Federation of Logistics and Purchasing (CFLP) said.

FT reports the UK PMI:

Strong foreign demand helped the UK manufacturing base record its twentieth consecutive month of expansion in March, a report released on Monday showed.

The latest poll from the Chartered Institute of Purchasing and Supply and Royal Bank of Scotland showed an index of manufacturing activity at 54.4 last month, as producers took advantage of a relatively healthy global economy...

However, the pace of expansion slowed somewhat from February’s 55.4 – a two and a half year high – prompting the City to marginally reduce expectations for an increase in interest rates this month.

Meanwhile, Reuters reports that the UK construction sector grew at its fastest pace in nearly three years in the first quarter.

The Royal Institution of Chartered Surveyors said its quarterly balance of construction workloads rose to +28 in the January to March period, up from +26 in the last quarter of 2006. This was the highest reading since the second quarter of 2004.

Inflation remains elevated

It looks like the hawks were right: Inflation remains a concern -- in the United States as well as much of the rest of the world.

With all the important measures of inflation for February now available, it has become clear that inflation in the US economy has not been subdued.

On 16 March, the Labor Department reported that the consumer price index rose 0.4 percent in February while the core index excluding food and energy rose 0.2 percent. On a 12-month basis, the respective increases were 2.4 percent and 2.7 percent. These rates are higher than the Federal Reserve's preferred rates of 1-2 percent.

The Federal Reserve, though, prefers to look at the personal consumption expenditure price index as a measure of inflation. This measure, however, provided little consolation too.

On Friday, the Commerce Department reported that the overall PCE price index rose 0.4 percent in February while the core index rose 0.3 percent. On a 12-month basis, the respective increases were 2.3 percent and 2.4 percent, only slightly better than the rate of increase of the respective CPI measures.

Not only do these figures show that inflation remains somewhat elevated, they also show that the moderating trend in inflation that had been evident in late 2006 appears to have stalled, at least for now. They also vindicate the Federal Reserve's persistent tightening bias and concern about inflation. Inflation is not going to lie down and die any time soon.

Indeed, in a speech on 23 March at the Federal Reserve Bank of San Francisco, Federal Reserve governor Frederic Mishkin said that while the core PCE inflation rate is likely to "gradually drift down" to around 2 per cent, he is "less optimistic about the prospects for core PCE inflation to move much below 2 percent in the absence of a determined effort by monetary policy".

Among other developed economies, inflation concerns are mixed. The euro area has managed to keep its inflation rate below 2 percent, although its estimate for March showed an acceleration to 1.9 percent from 1.8 percent in February. In the United Kingdom, though, inflation has over the past few months been flirting with the 3-percent threshold that would require the Bank of England to write a letter of explanation to the government. On the other hand, Japan's inflation rate fell back into negative territory in February.

Milton Friedman said that inflation is always and everywhere a monetary phenomenon. Perhaps that explains why inflation has been so persistent; with the exception of Japan, growth in money supply in the major economies has also been persistent, accelerating strongly in the euro area and the UK.


The Federal Reserve does not pay much attention to monetary aggregates, but that has not stopped it from remaining concerned about inflation.

On the other hand, the European Central Bank does monitor monetary aggregates closely and is among the more hawkish of the major central banks. It raised interest rates last month by a quarter percentage point to 3.75 percent.

The Bank of England looks like a strong candidate to be the next major central bank to hike rates.

Even the Bank of Japan appears committed to further tightening of monetary policy, albeit at a very gradual pace. With Japan's population set to shrink, growth in its money supply has a relatively limited impact on real economic activity in Japan and tends to feed carry trades instead.

Other central banks that raised interest rates in March include those of New Zealand, Denmark, Switzerland and Norway.

It is not just developed economies that are tightening monetary policy. Over the past fortnight, the central banks of both China and India have raised interest rates as well.

So the general trend in global monetary policy still appears to be towards more monetary tightening, and the Federal Reserve is unlikely to swim against the tide by cutting rates any time soon.