Tuesday 1 May 2007

Consumer spending weakening, time to inject more liquidity?

The United States Commerce Department released details on consumer spending in March yesterday. Reuters summarises these and other reports:

Overall consumer spending rose 0.3 percent in March, but expenditures actually dropped 0.2 percent once inflation was factored in, the first such decline in nine months. The spending softness came despite a solid 0.7 percent rise in incomes...

The report showed overall consumer prices rose 0.4 percent in March from February, but core prices outside of food and energy held steady...

But the National Association of Purchasing Management-Chicago's report suggested the pattern could be ephemeral, with the prices paid component rising to its highest level in nine months.

The group's overall business barometer fell to 52.9 in April from 61.7 in March, below Wall Street forecasts but above the 50-threshold that separates growth from contraction...

Strength in commercial building helped pull overall construction spending up 0.2 percent in March despite a decline in residential projects, separate Commerce Department data showed.

There was also disappointing data on consumer spending from Germany yesterday. Reuters reports:

German retail sales fell by 0.7 percent on the month in March, bucking expectations for a rise, preliminary Federal Statistics Office data showed on Monday.

But Europe generally appears to be in optimistic mood. Bloomberg reports:

European business and consumer confidence stayed close to a six-year high this month, indicating the euro-area economy is withstanding increased oil prices and borrowing costs as well as the slowdown in the U.S.

An index of sentiment among executives and consumers in the euro region slipped to 111.0 from a revised 111.1 the previous month, the European Commission in Brussels said today...

And rapid money supply growth continues to fuel the eurozone economy.

M3 money supply, which the ECB uses as a gauge of future inflation, rose 10.9 percent from a year earlier, the most since February 1983, after increasing 10 percent in February, the central bank said today. Economists expected the rate to drop to 9.8 percent, according to the median of 34 forecasts in a Bloomberg News survey.

The situation is beginning to look absurd to some.

"The ECB's concept" of M3 "seems more and more absurd to me," said Holger Sandte, an economist at WestLB in Dusseldorf. "Monetary policy is still not restrictive. There are several good reasons to increase interest rates further."

But inflation in the euro zone remains contained for the moment.

The European inflation rate fell to 1.8 percent in April from 1.9 percent in March, the European statistics office Eurostat said today, remaining below the ECB's limit for an eighth month.

In contrast, inflation in the UK could exceed target all year.

U.K. inflation will exceed the 2 percent target for another year because the Bank of England cut interest rates too far in 2005, the National Institute of Economic and Social Research said.

Consumer-price inflation will average 3 percent in the three months through June, and stay above the central bank's goal until the second quarter of 2008, the London-based research group, whose clients include the central bank and the U.K. Treasury, said today. The forecasts assume a fourth interest-rate increase to 5.5 percent in the second half of this year...

House prices rose the most in almost four years in April as London buyers snapped up properties amid a shortage of homes, a report by Hometrack Ltd. showed today. The average cost of a home in England and Wales rose an annual 6.8 percent, the most since June 2003, to 174,600 pounds, the research company said today.

Some critics are targeting the Bank of England's inflation-targeting, according to another Bloomberg report.

A decade after the central bank won its independence from government control, surging U.K. property values are throwing into question the inflation-targeting approach of Governor Mervyn King and his colleagues, which focuses on consumer prices as the lodestar of policy and gives lower priority to asset values, money supply and credit growth.

The bank's approach isn't broad enough to tackle asset bubbles that can burst and lead to recessions, says Tim Drayson, an economist at ABN Amro Holding NV in London who formerly worked at the U.K. Treasury.

While the BoE is being criticised for having been too easy on inflation, the Federal Reserve is being criticised for the opposite reason. From another Bloomberg report:

Federal Reserve Chairman Ben S. Bernanke's assertion that interest rates may need to increase to curb inflation is wrong. That's what Goldman Sachs Group Inc., Merrill Lynch & Co. and UBS AG are saying.

While Bernanke warned last month that the odds of worsening inflation have increased, chief economists at the three firms say the worst housing slump in a decade may drive the U.S. economy into a recession and stifle consumer prices. Their chief economists say the Fed will cut its target for overnight loans between banks at least three times this year.

One would assume that these economists are objective in their assessments, but some have doubts.

"There's a little bit of wishful thinking," said Susan M. Phillips, dean of the George Washington University School of Business in Washington and a governor of the Federal Reserve Board from 1991 through 1998. Fed officials have said "they'll be looking at what the data indicates," and since the last meeting of policy makers, "energy prices have taken a hike," she said in an interview.

She could have been more emphatic.

"Nobody in his right mind thinks the Fed will ease three times," said Stan Jonas, who trades interest-rate options in New York at Axiom Management Partners LLC, in an interview. "The marketplace is not saying that at all."

Anyway, perhaps the correct question to ask is: Does the world need more liquidity?

The Chinese authorities probably didn't think so when they recently decided to tighten again. The Chinese stock market's reaction yesterday to that move was interesting. From Xinhua Online:

Chinese shares soared to a new high on Monday, the day after the central bank announced it would again raise the deposit reserve ratio for financial institutions in the hope of cooling the booming economy.

The benchmark Shanghai Composite Index surged 2.16 percent, or 81.4 points, to close at a record 3,841.27 points. The turnover reached 188.656 billion yuan (24.5 billion U.S. dollars).

The Component Index of the smaller Shenzhen Stock Exchange rose 177.33 points, or 1.66 percent, to conclude trading at a record 10,865.88 points on a turnover of 92.636 billion yuan.

You can, like Andy Xie, predict a stock market crash all you want, but I suggest you don't bet on it coming anytime soon.

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