Global Markets Weekly – 8^th May 2007

Key Macro economic developments

• Three central banks, and three questions – how much, when and in which direction – are likely to dominate the economic agenda of the coming week. The market is currently regarding a rate hike in the UK as a virtual certainty, with seemingly only the size of the increase open for discussion. The European Central Bank (ECB), meanwhile, is expected to provide further guidance on the likely timing of its next policy tightening. But the outlook for the Federal Reserve (Fed) – facing a weaker growth profile and stubbornly high inflationary pressures in the United States – is far less certain, with many still questioning even the direction of the next move in interest rates.
• The deterioration that has occurred in the UK inflation data during recent months – culminating in the Bank of England Governor’s first letter of explanation regarding the inflation overshoot – has led to calls for aggressive action from some quarters, and speculation of a 50bp rate hike this week has subsequently intensified. Certainly, on the tenth anniversary of the formation of the Monetary Policy Committee (MPC), policymakers will be acutely aware of the need to maintain credibility and keep inflation expectations well anchored. But the largely conservative manner in which the MPC has operated during its first decade has served it well, and we continue to look for a 25bp hike (to 5.5%). Some pre-emptive monetary tightening is already in place, and with the lags with which policy changes influence economic activity being uncertain, the Committee will be wary of acting aggressively now.
• So far, UK households have apparently remained impervious to higher borrowing costs. Both the housing market and retail spending, for instance, continue to advance at a fair clip. But we believe that this response has merely been delayed rather than removed altogether. An unusually high proportion (around two-thirds) of new mortgage borrowing taken out over the past two years has been on a fixed interest rate basis, and many households will only begin to feel the impact of higher interest rates towards the end of this year. The MPC therefore faces a difficult task, having to talk tough on inflation in the near term but, equally, needing to avoid falling into the trap of policy overkill, where interest rates are pushed to an unnecessarily high level just as signs of a slowdown emerge. Faced with this challenge, we believe that a 25bp hike – with the threat of further action if required – is the most prudent course.
• The markets, meanwhile, will again be focusing on the nuances of ECB President Trichet’s press conference this week, looking for guidance on the likely timing of the expected rate hike, with June seen as a strong possibility. In the US, meanwhile, where policymakers face that most unwelcome of developments – stubborn inflationary pressures and a weak growth profile – no such certainties exist, and the markets will be eager for indications of how the Fed is currently prioritising these risks.

Key global market developments

• With equity markets having recovered to hit new peaks for the year and in some cases new all-time highs, are investors once again being complacent and ignoring the risks of another correction? The answer seems to be ‘no’. Although the market has risen, and some measures demonstrate a recovery of confidence, the surveys of investors do not suggest overconfidence, but instead a case of ‘once bitten, twice shy’. Indeed, as markets have hit new highs, investor confidence, as measured by the All American Individual Investors survey, has turned markedly more bearish.  While this does not preclude a correction, it implies that investors are better prepared for volatility and may even be holding off to buy on a correction. So, with valuations remaining positive, Coutts reiterates its positive stance on equity investment.

Indices, Interest rates and Inflation

	Close 27-Apr-07	1 Week%	1 Month%	3 Months%	YTD %
FTSE all share	3433.86	2.33	3.06	4.00	6.59
FTSE 100	6603.66	2.39	3.23	3.68	6.15
S&P 500	1509.48	1.83	4.55	4.10	6.43
Nasdaq Composite	2570.95	1.82	4.03	3.23	6.44
DJ Stoxx (Europe)	432.03	1.34	3.58	4.98	9.20
Nikkei 225	17669.83	1.55	1.06	2.18	2.58
Hang Seng	20896.64	2.84	3.40	1.05	4.67

Official Rates (%)				Inflation (%)	Rate announcement
	Current	Jun-07 Forecast	Dec-07  Forecast	Current	Next Date
US (Fed Funds)	5.25	5.25	5.00	2.8	9-May
UK (Base rate)	5.25	5.50	5.25	3.1	10-May
Euro-zone (Repo Rate)	3.75	4.00	4.00	1.9	10-May
Japan (Call rate)	0.50	0.50	0.75	-0.1	17-May

	Selected Global Indicators	Consensus Forecast	Previous Result		Date	Time
UK	Public Holiday				07-May
GE	Factory Orders (Mar)	-0.9%	3.9%	mom	07-May	11:00
GE	Industrial production (Mar)	-0.2%	0.9%	mom	08-May	11:00
US	FOMC announcement	5.25%	5.25%		09-May	19:15
UK	MPC announcement	5.50%	5.25%		10-May	12:00
EZ	ECB announcement	3.75%	3.75%		10-May	12:45
US	Trade balance (Mar)	-$60.0bn	-$58.4bn	month	10-May	13:30
US	Retail sales (Apr)	0.4%	0.7%	mom	11-May	13:30
US	PPI (Apr)	0.5%	1.0%	mom	11-May	13:30
US	Business inventories (Apr)	0.2%	0.3%	mom	11-May	15:00

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