Global Markets Weekly – 26^th February 2007

Key Macro economic developments

• Significant data releases were fairly thin on the ground last week, with the January consumer price index (CPI) data from the US arguably the highlight. In the event, a significant drop in energy prices during the month helped the annual rate of headline inflation move down from 2.5% to 2.1%, but the profile of ‘core’ inflation (headline CPI excluding food & energy prices) attracted most attention, particularly after the recent communications from US rate setters on this issue. Federal Reserve Chairman Bernanke had earlier this month sounded reasonably confident over the likelihood of underlying inflationary pressures easing over the coming year, but warned that this process may not develop as rapidly as he would hope. Such concerns also featured within the minutes of the Federal Open Market Committee’s (FOMC) January 30^th/31^st meeting, where the upside risks to inflation were described as the FOMC’s ‘predominant’ concern.
• This caution looks to be well founded judging by the January CPI figures, as after several months of only meagre rises, core consumer prices increased by a stronger than expected 0.3% in the month, pushing the annual rate of core inflation back up towards a 2.7% rate. This is still some way above the Fed’s perceived comfort range (a narrow band around the 2% level), and the broad-based nature of the increase in price pressures during January will have been a further disappointment for policymakers. As such, we do not expect the Fed to soften its hawkish rhetoric anytime soon, even if the most recent activity data have pointed to a rather damp start to 2007, and the stabilisation of energy prices helps the headline measures of inflation move steadily lower over the coming months.
• Indeed, how the major central banks react to this expected reduction in headline inflation rates will be an intriguing issue for the financial markets. The Bank of England’s latest inflation projections (the details of which were released last week) call for the headline rate of CPI inflation to fall sharply - eventually moving below the 2% target rate by Q1 2008 - but this appears unlikely to prevent a further rate hike, most likely during the second quarter of this year. The European Central Bank (ECB), meanwhile, has barely acknowledged the recent fall in Euro-zone inflation below its own 2% threshold level, instead concentrating upon the troubling pace of monetary growth and, increasingly, concerns over the level of spare resources within the region’s economy. And while neither the Bank of England or ECB’s policy mandates contain any explicit reference to asset prices, developments here will undoubtedly influence their respective decision making processes over the coming months.
• The prevailing level of inflation should not, of course, be the predominant influence upon monetary policy due to the lags with which interest rate changes work. Pre-emptive, rather than reactive, behaviour is required. Nevertheless, central bankers are likely to pay an unusually low level of attention to the expected decline in headline inflation rates of the coming months, instead consulting a broad range of indicators of underlying price pressures. This appears particularly true of the Bank of England, which looks to be placing increasing significance upon surveys of industry pricing intentions and consumer inflation expectations that have hitherto only exerted a limited influence upon policy.

Key global market developments

• Gold has hit a nine-month high of $677.  The most immediate cause was that day’s announcement that Iran remained defiantly in breach of the UN resolution on its nuclear development programme.  However gold has been rising steadily since it hit its low this year of $604 on 5 January, as recovering confidence over the outlook for the US and global economies has driven a rally in most commodity prices.  This is highlighted by the Fed’s recent warnings about inflation risks, which was especially supportive for gold.  That gold remained above $600 even at its low point this year is itself significant, indicating the level of investor support above that level.  Investors remain keen to diversify their assets, hedging the gains made from four years of bull markets.

Indices, Interest rates and Inflation

	Close 23-Feb-07	1 Week%	1 Month%	3 Months%	YTD %
FTSE all share	3321.39	-0.15	3.08	5.09	3.10
FTSE 100	6401.49	-0.28	2.79	4.26	2.90
S&P 500	1451.19	-0.30	1.63	3.21	2.32
Nasdaq Composite	2515.10	0.75	3.44	1.99	4.13
DJ Stoxx (Europe)	413.27	0.10	3.22	6.35	4.46
Nikkei 225	18188.42	1.75	4.48	14.29	5.59
Hang Seng	20711.65	0.70	-0.28	7.51	3.74

Official Rates (%)				Inflation (%)	Rate announcement
	Current	Jun-07 Forecast	Dec-07  Forecast	Current	Next Date
US (Fed Funds)	5.25	5.25	5.00	2.1	21-Mar
UK (Base rate)	5.25	5.50	5.25	2.7	8-Mar
Euro-zone (Repo Rate)	3.50	3.75	3.75	1.9	8-Mar
Japan (Call rate)	0.50	0.50	0.75	0.3	20-Mar

	Selected Global Indicators	Consensus Forecast	Previous Result		Date	Time
UK	CBI Distributive Trades survey (Feb)			month	27-Feb	11:00
US	Durable Goods Orders (Jan)	-1.9%	2.9%	mom	27-Feb	13:30
US	Consumer Confidence (Feb)	109.0	110.3	month	27-Feb	15:00
US	Existing Home Sales (Jan)	6.24m	6.22mn	saar	27-Feb	15:00
US	Chicago PMI (Feb)	50.0	48.8	month	28-Feb	14:45
US	New Home Sales (Jan)	1085k	1120k	mom	28-Feb	15:00
EZ	PMI manufacturing (Feb)	55.8	55.5	month	01-Mar	09:00
UK	Mortgage Approvals (Jan)	115k	113k	month	01-Mar	09:30
EZ	HICP (Feb-flash)	1.9%	1.9%	yoy	01-Mar	10:00
US	Core PCE deflator (Jan)	2.3%	2.2%	yoy	01-Mar	13:30
US	ISM manufacturing (Feb)	50.0	49.3	month	01-Mar	09:00

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