Global Markets Weekly – 22^nd January 2007

Key Macro economic developments

• The UK data releases last week - consumer price inflation, average earnings/unemployment and retail sales – while clearly highlighting the upside risks to inflation, stopped short of fully explaining the Monetary Policy Committee’s (MPC) haste in raising rates earlier this month. The headline rate of consumer price inflation moved up to 3% in December, a series high but still within the MPC’s range of tolerance (a percentage point either side of the 2% symmetrical inflation target), while average earnings growth actually declined marginally in the three months to November. Admittedly, relatively few wage negotiations occur in November (an estimated 3% of the total) but the threat of a wage-price spiral developing in the UK economy still appears to be more prospective than real at present.
• Speeches by two Committee members last week - Timothy Besley and Andrew Sentance - also failed to move the debate on significantly and while the retail sales figure for December surprised on the upside, a strong finish to the year (in terms of GDP growth) has long been a feature of policymakers’ thinking. The standout report from the week was arguably the latest quarterly economic report from the British Chambers of Commerce, which showed indicators of demand, price growth and business expectations to be at elevated levels. This survey is not typically viewed as either a ‘market mover’ or one that unduly influences monetary policy. But it may be possible that the MPC’s renewed focus upon developments on the supply-side of the UK economy, and their attempts to capture developments such as changes in inflation expectations, pricing power and wage negotiating behaviour, has led to a wider range of indicators being analysed and more ‘on the ground’ intelligence (including that provided by the Bank’s regional agents) being used. But the data releases have still failed to fully explain the haste with which interest rates were increased this month, and a degree of intrigue therefore still surrounds this latest policy decision. The minutes of this month’s MPC meeting, published on Wednesday, have consequently become the most eagerly awaited in recent memory.

Key global market developments

• The yen suffered a further setback, moving beyond the Y120 level and towards an almost four year low against the dollar, after the Bank of Japan (BoJ) opted to leave interest rates on hold following their monetary policy meeting last week. The rate call had been finely balanced, and the likely 25bp hike is seen to have been postponed rather than abandoned, with a move now expected at the BoJ’s February 20^th/21^st policy meeting. But it was the circumstances around the BoJ’s decision, and the possibility that external political pressure may have been an influence, that proved so troubling for the beleaguered currency and a catalyst for a yen recovery is not currently easy to identify.
• While interest rates remain at unusually low levels (call rate at just 0.25%), and some steady recovery in the Japanese economy seems to be progressing, the higher frequency economic and financial data have largely failed to make a compelling case for an early rate hike. In retrospect, the BoJ’s move back in December to downgrade the outlook for consumption was perhaps an indication that a more gradual tightening of monetary policy was being considered. But the suggestion of political interference by the ruling LDP party, the split vote (6-3) that backed the decision to remain on hold and the rather backward-looking comments by BoJ chief Fukui at last week’s press conference did little to inspire confidence. Moreover, the events of the last week have hardly challenged the perception that the yen remains a funding currency for investment elsewhere, and it was interesting to note the stronger performance of the higher-yielding currencies in the wake of the BoJ decision last week. Nevertheless, with the Japanese fiscal year-end looming on the horizon, raising the prospect of a significant flow of funds back into Japan, some of the current pressure on the yen could be about to lift and the currency’s performance during this period could speak volumes as to the true potential for a yen recovery this year.

Indices, Interest rates and Inflation

Disclaimer

Issued by Coutts & Co, which is authorised and regulated by the Financial Services Authority.

The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.  Past performance is not necessarily a guide to future performance.  Where an investment involves exposure to a foreign currency, changes in rates of exchange may cause the value of the investment, and the income from it, to go up or down.

The information in this document is not intended as an offer or solicitation to buy or sell securities or any other investment or banking product, nor does it constitute a personal recommendation.  The information shown is believed to be correct but cannot be guaranteed.  Any opinion or forecast constitutes our judgement as at the date of issue and is subject to change without notice.  Any Coutts company, or a connected company, its clients and officers may have a position or engage in transactions in any of the securities mentioned.

The research and analysis in this document have been procured, and may have been acted upon, by Coutts & Co and connected companies for their own purposes, and the results are being made available to you on this understanding.  Neither Coutts & Co nor any connected company accepts responsibility for any direct or indirect or consequential loss suffered by you or any other person as a result of your acting, or deciding not to act, in reliance upon such research and analysis.

Not all products and services offered by the individual Coutts companies are available in all jurisdictions, and some products and services may be available only through particular Coutts companies.  Investment services for US residents are provided by Coutts & Co Investment Management Limited, an Investment Advisor registered with the Securities and Exchange Commission under the Investment Advisors Act 1940 and authorised and regulated by the Financial Services Authority in the UK.

None of the overseas Coutts companies or offices is an Authorised Person subject to the rules and regulations made under the Financial Services and Markets Act 2000 for the protection of investors and depositors, and compensation under the Financial Services Compensation Scheme will not be available in respect of business transacted with them.

Coutts (Cayman) Limited. Registered Office: Coutts House, 1446 West Bay Road, PO Box 707, Grand Cayman KY1-1107, Cayman Islands.  Licensed under the Banks and Trust Companies Law (2003 Revision). Coutts (Cayman) Limited is not regulated by the Cayman Islands Monetary Authority in its conduct of securities investment business.

Coutts Offshore Europe Limited.  Registered office: 23-25 Broad Street, St Helier, Jersey JE4 8ND.  Regulated by the Jersey Financial Services Commission for carrying on investment and trust company business. Regulated by the Guernsey Financial Services Commission for carrying on investment business.  Trading in Jersey as Coutts Channel Islands.  Business address in Isle of Man: PO Box 59, Royal Bank House, 2 Victoria Street, Douglas, Isle of Man, IM99 1DU.  Licensed by the Isle of Man Financial Supervision Commission for Investment and Corporate Service Provider business.  Trading the in Isle of Man as Coutts Isle of Man.