Global Markets

Action last week revolved around numerous central bank policy meetings and announcements. While four maintained current policies the European Central Bank surprised global markets by cutting its interest rates and saying it would begin buying asset backed securities next month. For the week, most equity indexes advanced.

European Central Bank

The European Central Bank announced a surprise cut in key interest rates at its September monetary policy meeting. The benchmark refi rate was trimmed 10 basis points to a new record low of 0.05 percent while the rates on the deposit and marginal lending facilities were reduced by an equivalent amount to minus 0.2 percent and 0.3 percent respectively. Interest rates are now officially viewed as being at their lower bound (although note that the same description was applied to the June cut).

The ECB also announced that it will begin purchasing a broad portfolio of asset backed securities and covered bonds with a view to boosting the liquidity available to the private sector. Details of the ABS program will be made available on October 2nd.

Though there was heightened speculation that some form of additional monetary accommodation was just a matter of time, the outcome was not generally expected. Note that the reduction in rates did not receive a unanimous vote. In practice any impact from a 10 basis point cut in official borrowing costs from already near-zero levels is likely to be more psychological than anything else. Moreover the limited size of the ABS market should raise at least a few doubts about just how effective the asset buying program will be. Nonetheless, both initiatives clearly reflect a significant shift in the ECB's economic view which, at last, seems to be taking on board the increasing risk of deflation.

Eurozone economic news since the Governing Council meeting in August has been decidedly disappointing, including the surprise stagnation of the real economy in the second quarter, another fall in (flash) inflation in July to a near five year low (just 0.3 percent) and fresh declines in the both August PMIs and economic sentiment. Furthermore, the ECB can no longer claim that inflation expectations remain anchored and it is probably this as much as any other economic indicator that has undermined the notion that the previous policy stance was appropriate.

The announcement of additional easing moves comes ahead of the two 2014 targeted longer-term repo operations (TLTROs) announced in July that will be held on September 18^th and December 11^th. Many had thought that the ECB would want to see the impact of these before taking any additional steps. However with banks aggressively repaying their earlier long term loans, the ECB's balance sheet has been shrinking quite steadily during 2014 (by about €0.2 trillion to date) and is already more than €1 trillion smaller than it was in mid-2012. Consequently, the potential effects of the TLTROs — which could boost liquidity by a maximum of €400 billon — may only be limited anyway. A further six additional TLTROs are scheduled through June 2016.

The Banks of Japan, Canada and England also met last week along with the Reserve Bank of Australia. All left their respective monetary policies unchanged.

As universally anticipated, the Bank of Japan left its key interest rate range at zero to 0.1 percent. Financial asset purchases remained unchanged, with the goal of increasing the monetary base at an annual pace of about ¥60 to ¥70 trillion yen. The BoJ maintained its inflation target at 2 percent but sees a shortfall. It projects the consumer price index to be about 1.25 percent for some time. The BoJ said that the economy "continued to recover moderately as a trend."

At his press conference, BoJ Governor Haruhiko Kuroda said that Japan's economy is expected to continue on a moderate recovery path. Even though second quarter gross domestic product contracted at an annualized pace of 6.8 percent, he said the economy "has been growing above its potential growth rate" especially in the first quarter when consumers and businesses rushed out to buy ahead of the implementation of the sales tax increase from 5 percent to 8 percent on April 1st. Mr Kuroda said that the declines in domestic demand, due to effects from Japan's sales tax increase, are expected to wane gradually.

As expected the Bank of Canada left interest rates unchanged with the target for the key overnight rate at 1.0 percent, the Bank Rate at 1.25 percent and the deposit rate at 0.75 percent. There was also no change to the neutral bias with the final sentence of the central bank's press statement employing virtually identical language to that used in July.

As expected, the Bank of England's September monetary policy committee meeting concluded with the announcement of no change to either Bank Rate (0.5 percent) or its asset purchase ceiling (£375 billion). However, in line with the August vote, there were probably at least a few dissenters (McCafferty and Weale last time) who wanted to see the Bank Rate raised immediately. Recent economic data over the last month or so have generally been on the soft side of expectations, notably CPI inflation which dropped to 1.6 percent in July and retail sales which were barely changed in the same month. The August manufacturing PMI was also surprisingly subdued although both services and construction seem to be motoring ahead. Lending similarly remains sluggish and, of increasing importance, wage growth has turned negative.

As expected the Reserve Bank of Australia left its key interest rate at 2.5 percent where it has been since August 2013. Governor Glenn Stevens continued to signal very clearly that the bank will adopt a wait and see approach before changing tack. All communication to date has clearly stated that until the 'period of stability in interest rates' is dropped from the statement, rates will be unchanged. The Board repeated that the Australian dollar is offering less assistance in economic rebalancing. The currency remains above most estimates of fundamental value. Regarding unemployment, the Board said that the unemployment rate is up despite improvement in most labour indicators. It remarked that it would be some time before unemployment declines consistently.

Global Stock Market Recap

Europe and the UK

Equities advanced last week as investors waited for and then reacted to the monetary policy moves by the European Central Bank. Initially investors celebrated the ECB's easing. But on Friday they were wary of the moves. They were concerned that the stimulus measures are not sufficient to spur economic activity. A weaker than anticipated U.S. employment situation report Friday contributed to lackluster equity index performance as well. On the week, the FTSE was up 0.5 percent and the SMI gained 1.5 percent. The CAC and DAX added 2.4 percent and 2.9 percent respectively. Equities in Italy (MIB) and Spain (IBEX) rallied for gains of 4.6 percent and 3.9 percent.

Ukraine sanctions against Russia are beginning to impact some economies negatively. For example pears are being left on the trees because of Russia's ban on certain imports from the European Union, U.S. and other countries. Russia, the biggest buyer of European pears, last month banned an array of food imports. The restrictions pushed prices lower for everything from Spanish peaches to Latvian cabbage to Finnish dairy products.

The FTSE has been resilient in the face of uncertainty over Scotland's vote later this month over whether or not to stay in the United Kingdom. While uncertainty over the Scotland vote has hit the pound sterling, it has so far had relatively little impact on companies in the FTSE which are often more exposed to the global economy than the UK economy.

The Eurozone August manufacturing PMI was 50.7, down slightly from the flash reading of 50.8 and down from July's final of 51.8. Growth of new orders posted its weakest rate during the current 14-month long upswing and backlogs fell further. Headcount was down and while the drop was only marginal, it was still the steepest since November 2013. Signs of worsening confidence were apparent in input buying volumes which declined for the first time in more than a year as well as an additional rundown in inventories.

Easily the best performer was Ireland where the PMI hit a multi-month high of 57.3. However, the next strongest member was Spain whose index (52.8) was more than 4 points weaker. Among the other larger members, Germany (51.4) saw an 11-month low but at least remained in positive growth territory while both France (46.9) and Italy (49.8) posted sub-50 readings. With Greece essentially stagnating at 50.1, the deceleration among peripherals, where growth had been strong, is a notable feature.

Asia Pacific

Equities were mostly higher last week as investors remained cautious given the run of central bank announcements that were scheduled for the week and that ended with the U.S. employment report in the Friday global market day. There was little reaction to the European Central Bank's monetary policy changes Friday although Japanese markets received a lift after the yen hit a six year low as the U.S. dollar strengthened. Analysts opined that Asia-Pacific investors do not see how a cut in interest rates and a broad bond buying program in the Eurozone will affect them. Investors here also kept a wary eye on geopolitical news from Ukraine and the Middle East.

Gains ranged from 0.1 percent (KLCI) to 4.9 percent (Shanghai Composite). The Hang Seng added 2.0 percent and the PSEi was 3.0 percent higher. However, the Kospi lost 0.9 percent, the All Ordinaries was down 0.5 percent and the Taiex was 0.3 percent lower. Chinese stocks rallied on reports that showed faster growth in China's service industries. Equities also received a boost from U.S. manufacturing data.

In Japan, equities usually are affected more by the value of the yen then policy changes elsewhere. However, the Nikkei responded positively to changes in Prime Minister Shinzo Abe's cabinet. The appointment Wednesday of a new health, labor and welfare minister has boosted domestic stocks, with local investors expecting the $1.2 trillion public pension fund to invest more in the domestic market. The index added 1.6 percent on the week.

Currencies

The U.S. dollar advanced against all of its major counterparts last week including the euro, yen, pound sterling, Swiss franc and the Canadian dollar even though it slipped after the disappointing employment report Friday. However, it retreated against the Australian dollar. The euro slid against all of its counterparts after the European Central Bank lowered its key interest rates and introduced a bond buying program.

The Japanese yen touched a six year low Thursday. Since markets began to price in an electoral victory for Shinzo Abe in October 2012, the yen has tumbled more than 30 percent. The bulk of those moves took place in 2013, as Mr Abe — with a bit of help from the Bank of Japan — announced fiscal and monetary easing coupled with plans for structural reforms. Then, in mid-August, the yen resumed its slide which spurred an equity rally. Analysts note that the current slide has more to do with U.S. dollar strength, rather than renewed optimism on structural reforms from Mr Abe. A key reason that the yen depreciated late in the week was that Bank of Japan Governor Haruhiko Kuroda suggested that it made sense for the dollar to strengthen further given the divergent trends in monetary policy between the U.S. and Japan.

The euro weakened against the dollar after ECB President Mario Draghi told a press conference Thursday that the Bank will begin buying asset backed securities next month in a bid to stimulate lending in the Eurozone. The decision to buy securities made up of loans to businesses is less of a surprise than the companion interest rate cut, but underlines that officials believe the inflation and growth picture has deteriorated since they last met in August.

Selected currencies — weekly results

Indicator scoreboard

EMU

July retail sales declined 0.4 percent on the month and were up just 0.8 percent on the year. Food, drink & tobacco sales were down 0.6 percent from the end of last quarter. Excluding auto fuel, non-food demand declined a more modest 0.2 percent. Regionally, the headline drop was dominated by Germany where sales were down 1.4 percent on the month, their fourth decline in the last five months. France slid 0.3 percent and Spain was 0.4 percent lower. However, within the usual mixed national picture there were more than respectable increases in Latvia (2.2 percent), Estonia (1.6 percent) and Slovenia (1.5 percent).

Second quarter gross domestic product was unrevised in the second estimate. On the quarter, GDP was unchanged and up 0.7 percent on the year. Household spending accelerated but, at a sluggish 0.3 pace. Fixed capital formation contracted 0.3 percent, more than offsetting the previous period's 0.2 percent increase. Otherwise, government consumption was up 0.2 percent (0.1 percent in Q1) while business inventories cut 0.2 percentage points from the quarterly change in total output. Economic growth would have been negative but for a 0.1 percentage point contribution from foreign trade as exports rose 0.5 percent and imports 0.3 percent. Quarterly contractions in Germany and Italy (both 0.2 percent) did much of the damage although France was only flat. Spanish growth picked up from 0.4 percent in the first quarter to 0.6 percent. Elsewhere Finland (0.2 percent) and Estonia (0.5 percent) both emerged from recession and the pace of decline in Cyprus (0.3 percent) at least slowed. The best performing member states were Malta (1.3 percent) and Latvia (1.0 percent).

Germany

July manufacturing orders jumped 4.6 percent on the month following a shallower revised 2.7 percent drop in June. The monthly increase was their best performance since June 2013 and boosted seasonally and workday adjusted growth from minus 1.9 percent to plus 4.9 percent. July's surge was dominated by the recently underperforming capital goods sector where orders were up 8.5 percent from the end of the second quarter. Elsewhere, however, the news was not nearly as positive with basics advancing just 0.3 percent and consumer & durables falling 2.9 percent. Moreover, most of the headline gain was attributable to overseas demand which posted a 6.9 percent monthly bounce (Eurozone 1.7 percent). By contrast domestic orders increased a relatively subdued 1.7 percent.

July industrial production was up 1.9 percent on the month and the steepest since March 2012, followed a slightly larger revised 0.4 percent increase in June to lift annual output growth from minus 0.3 percent to 2.4 percent. The headline advance was led by the capital goods sector where production expanded 5.0 percent on the month following a 0.4 percent drop last time. Intermediates saw a 0.8 percent increase and consumer goods edged up 0.1 percent. Energy posted a 3.7 percent reversal but construction grew 1.7 percent and overall manufacturing was up a very solid 2.6 percent.

Switzerland

Second quarter gross domestic product was flat on the quarter following unrevised quarterly growth of 0.5 percent at the start of the year. Compared with a year ago total output was up just 0.6 percent, a sharp deceleration from the marginally firmer revised 2.1 percent annual rate posted last time. Final domestic demand was soft again, edging up only a quarterly 0.1 percent after no growth at all in the previous period. Within this, household spending was up a modest 0.2 percent but gross fixed capital formation stalled as a 0.7 percent increase in fixed assets & software was offset by an equivalent decline in construction. Government expenditure was down 0.3 percent, compounding the 0.7 percent drop posted in the first quarter. Growth at the start of the year was heavily reliant upon overseas demand but this time foreign trade had a small negative impact as the benefits of a 0.6 percent quarterly advance in exports were wiped out by a 0.9 percent gain in imports.

Asia/Pacific

Australia

Second quarter gross domestic product growth slowed to a gain of 0.5 percent on the quarter and 3.1 percent when compared with the same quarter a year ago. Analysts had expected an increase of 0.3 percent on the quarter and 2.9 percent from a year ago. The Australian Bureau of Statistics noted that net exports were the main detractor from GDP, accounting for a 0.9 percentage point decline. Offsetting that decline was inventory accumulation and consumption. Mining was still the biggest contributor to growth, accounting for 1.2 percentage points. The 3.4 percent annual gain in the first quarter was regarded as exceptionally high due to a quirk in how Australian statisticians seasonally adjust mining output. Clement weather flattered how the contribution from the nation's mining industry was measured during what is traditionally a poor quarter. As the prices of key commodities such as iron ore fell, Australia's terms of trade — a metric measuring buying power abroad, based on prices of exports compared with prices of imports — fell 4.1 percent in the quarter, after a 1.4 percent fall in the first quarter. Over 12 months the country's terms of trade declined 7.9 percent.

July seasonally adjusted retail sales were up 0.4 percent as expected after increasing 0.6 percent in June. On the year, sales were up 5.9 percent. The largest contributor to the increase was cafes, restaurants & takeaway food services (1.4 percent) followed by food retailing (0.5 percent), department stores (1.9 percent) and clothing, footwear & personal accessory retailing (0.1 percent). The increase was partially offset by declines in other retailing (down 0.6 percent) and household goods retailing (down 0.2 percent). Sales were up 0.7 percent in New South Wales followed by a 0.6 percent increase in Victoria. Sales in the Australian Capital Territory (2.6 percent), South Australia (0.4 percent) and Queensland (0.1 percent) also contributed to the increase in sales. The increases were partially offset by declines in the Northern Territory (down 2.3 percent), Western Australia (down 0.1 percent) and Tasmania (down 0.4 percent).

July merchandise trade deficit eased to a shortfall of A$1.4 billion from a revised A$1.6 billion in June. Exports were up 1.0 percent while imports added 0.3 percent. Rural goods exports were up 2 percent while non-rural exports edged up A$44 million. Non-monetary gold exports jumped 14 percent. Imports of intermediate and other merchandise goods edged up 1 percent while consumption goods were up A$19 million. Non-monetary good dropped 23 percent while capital goods edged down A$2 million.

Americas

Canada

July international trade surplus was C$2.58 billion, up from June's slightly smaller revised C$1.83 billion surplus in June. The real trade balance also improved sharply as export volumes were up 1.1 percent on the month and price-adjusted imports gained just 0.4 percent. The monthly improvement reflected a 1.4 increase in nominal exports and a 0.3 percent decline in imports. Sales to the key U.S. market were up 1.9 percent while purchases from across the border grew 1.2 percent. As a result, the bilateral black ink with the U.S. widened from C$4.45 billion to C$5.14 billion. Within the overall monthly increase in nominal exports, there were strong gains in motor vehicles & parts (9.7 percent), electronic & electrical equipment & parts (6.9 percent) as well as in farm, fishing & intermediate food products (3.0 percent). The main decline was in metal ores & non-metallic minerals (down 2.5 percent). Imports were held in check by monthly declines in aircraft & other transportation equipment & parts (down 11.9 percent) and metal & non-metallic mineral products (down 4.4 percent).

August employment declined 11,000 following the upwardly revised gain in July. The unemployment rate remained at 7.0 percent while the participation rate slipped 0.1 percentage point to 66.0 percent. August's headline deterioration was largely attributable to part-time jobs which were down 8,700. Full-time positions were down a smaller 2,300. However, there were widely divergent trends between the private and public sector payrolls. While the former posted a drop of nearly 112,000, easily more than reversing July's 54,600 jump, the latter was up 14,000 after a 24,200 increase last time. Accordingly, the overall change in employment would have been a good deal more negative but for an 86,900 surge in the number of self-employed. Services were weak, recording a 21,000 decline largely on the back of a 26,500 slump in trade. Other sizeable declines were seen in transportation & warehousing (14,700), finance, insurance, real estate & leasing (13,500) and information, culture & recreation (10,600). The steepest monthly gain was in professional, scientific & technical services (21,300) ahead of public administration (20,500). By contrast, the goods producing sector added 10,100 to its headcount. However, manufacturing was off 11,000 and there were smaller declines in utilities (3,300) and natural resources (2,100). Partial offsets were registered in construction (24,400) and agriculture (2,000).

Bottom line

Among the many central bank announcements last week, only the European Central Bank changed its monetary policy. August PMIs in Europe disappointed while those for services in China improved. August employment in Canada declined while in the U.S., it increased less than anticipated.

Next week will be comparatively quiet. Only the Reserve Bank of New Zealand meets. European data are focused on merchandise trade balances and output data. China releases its August inflation data while Japan reports revised second quarter GDP.

Looking Ahead: September 8 through September 12, 2014

Anne D Picker is the author of International Economic Indicators and Central Banks.