Global Markets

Most equities advanced last week despite geopolitical strains from Ukraine and the Middle East. In economic data, the plus side emanated from improving flash PMI readings in China and the Eurozone. However, on the minus side were mixed company earnings out of the U.S., Japanese trade statistics, U.S. new home sales and the German Ifo survey.

Lithuania approved to join EMU

The EU Council formally approved Lithuania's membership of the European Monetary Union, effective January 1, 2015. The ECB will assume responsibility for the supervision of the country's largest banks at that time. The European Council also announced the conversion rate for Lithuania's currency — 3.4528 litas to the euro. Following more than a decade of operating within the tight confines of the exchange rate mechanism, Lithuania will become the 19th member of the single currency. Implications for the euro should be minimal as Lithuania will account for less than 1.0 percent of Eurozone total output.

Lithuania is the last of the prospective EMU members with a recognized timetable. Bulgaria, Czech Republic, Hungary, Poland and Romania have all expressed their desire to become part of the currency union but do not yet meet all of the membership criteria. Any additional expansion is probably several years away.

The country's accession to the euro will also mark a procedural change at the European Central Bank. Up to now, all members of the central bank's policy setting Governing Council have had a vote on policy. This will change next year with voting rights now to be divided according to the nation's size. The largest five nations will share four votes with the smaller 14 nations sharing 11 votes.

This change has ruffled some feathers in Germany, since it will mean that once every five meetings, Deutsche Bundesbank President Jens Weidmann will not vote. He has on occasion been a lone voice of dissent against ECB President Mario Draghi, notably objecting to Mr Draghi's program to buy bonds of countries in crisis in what is known as the Outright Monetary Transactions (OMT) program.

IMF cuts global growth forecast

The International Monetary Fund has reduced its 2014 growth forecast from 3.7 percent to 3.4 percent after a dismal first quarter in the United States and weakness in big emerging markets. Updating the forecasts in its World Economic Outlook that was released in April, the IMF said it expects growth to rebound during the rest of 2014 but warned that "downside risks remain a concern". The IMF continues to forecast global growth of 4 percent in 2015.

The Organization cut its U.S. forecast to just 1.8 percent this year, down from 2.2 percent in April. The Federal Reserve calls for growth of 2.2 percent in 2014. The IMF kept its Eurozone growth forecast at 1.1 percent and upgraded its Japan forecast from 1.3 percent to 1.6 percent. The Fund downgraded its growth forecasts for most big emerging markets. It took its Russia forecast down to 0.2 percent from 1.3 percent because of the crisis in Ukraine. It edged its China forecast down from 7.6 percent to 7.4 percent and cut its Brazil forecast sharply from 1.9 percent to 1.3 percent.

Global Stock Market Recap

Europe and the UK

Equities were mixed last week. The FTSE and SMI were up 0.6 percent and 0.7 percent respectively while the CAC and DAX lost 0.1 percent and 0.8 percent. European stocks declined sharply on Friday, ending a roller coaster week on a downbeat note as traders feared an escalation of geopolitical tensions over the weekend in Ukraine and the Middle East. Also depressing investors Friday was the reading on German business confidence — it marked a third straight monthly decline, falling short of expectations and sparking fresh concerns about the pace of Eurozone recovery.

Underpinning the FTSE's weekly gain was the news that the UK economy expanded 0.8 percent in the second quarter and 3.1 percent from a year ago. The economy has recouped all that was lost, and then some, from the financial crisis struck six years ago. But the FTSE succumbed to profit taking in late trading Friday on geopolitical concerns that revived investor concerns about the conflict in Ukraine.

July flash composite PMI climbed 1.2 points to 54.0 for a 3-month high and off June's six-month low. The improvement in total output was led by services where the PMI was provisionally put at 54.4, a 1.6 point increase from its final June mark and its strongest in 38 months.

Manufacturing (51.9) showed little change from last time but at least remained above the key 50 expansion threshold. New orders growth slowed slightly in July with anecdotal evidence suggesting that geopolitical problems were hampering overseas demand. Probably as a result, employment gains in both services and manufacturing were again only modest. Inflation developments were mixed but overall still soft. While overall input cost inflation was unchanged from June's 7-month high, factory gate prices rose for a third consecutive month. However, service provider charges were down for the 32nd month in a row. Regionally the German composite output index jumped to 55.9 after 54.0 and was enough to ensure a further widening in the performance gap with France (49.4 after 48.1). France is still struggling to achieve any growth at all. Elsewhere in the region, business activity recorded its strongest monthly advance since August 2007.

Bank of England publishes minutes

Because the Bank of England is anticipated to increase its key interest rate sooner than the Federal Reserve, the monetary policy committee's deliberations got more attention last week than they usually do. As expected, the minutes of the monetary policy committee meeting held earlier this month showed another unanimous 9 to 0 vote for no change in either the Bank Rate (0.5 percent) or the asset purchase ceiling (Stg375 billion). However, in line with the June deliberations, there were clear signs of cracks beginning to form in the Committee's unanimity, keeping alive the possibility of a monetary tightening before year end.

Some members saw the output gap narrowing more quickly than officially forecast and would appear to be leaning in the direction of a preemptive interest rate increase in order to reduce the eventual extent of tightening further out. An early move was also considered as a potentially useful test of how the key household sector would react to higher borrowing costs. Nonetheless, given little indication of any domestically generated inflationary pressure and with the pound sterling increasingly overvalued and the global economy undershooting expectations, the decision to maintain the status quo was always going to be the most likely outcome.

Since this month's meeting, economic news has continued mixed and probably best summed by the labour market. Here, unemployment is still falling surprisingly fast but wages have simply not responded. The economy, as Friday's provisional second quarter GDP report underlined, is expanding at a rapid clip so there is certainly no need for additional accommodation. Rather the question is how long it will take for a majority of MPC members to regard the current divorce between growth and inflation as unsustainable and to bite the interest rate bullet even with the CPI still behaving itself.

Asia Pacific

Equities advanced last week amid mixed economic news. Lingering concerns about ongoing conflicts in Ukraine and the Middle East and the IMF's weak global forecast kept gains muted. Shares in China and Hong Kong scored the biggest gains thanks to a better than expected July flash manufacturing PMI reading. The Shanghai Composite and Hang Seng added 3.3 percent and 3.2 percent respectively. Also contributing to the increases was a decline in Chinese money market rates.

A preliminary survey by Markit and HSBC indicated that China's manufacturing activity grew at the quickest pace in 18 months in July, exceeding expectations. The PMI climbed to 52.0 from 50.7 in June, signaling expansion for the second consecutive month.

In Japan, the Nikkei was up 1.6 percent on the week. According to Bank of Japan Deputy Governor Hiroshi Nakaso, quantitative and qualitative monetary easing policy introduced by the BoJ to reach its target 2 percent inflation rate has been having its intended effects. The deputy governor said that though the current inflation rate of 1.25 percent is only half of the 2.0 percent target, the desired rate will be reached in or around 2015. In the latest reading of consumer prices, the key core CPI which excludes fresh food was up 3.3 percent from June 2013 after climbing 3.4 percent in May. However, excluding the impact of the April first sales tax increase, the index was estimated to be up only 1.3 percent on the year. In other economic news, the merchandise trade deficit expanded while the flash July manufacturing PMI indicated that the sector, while growing slowly, is stagnating.

The Japanese government downgraded its growth outlook for the fiscal year 2014 (ending March 31, 2015) citing weak exports and subdued demand after the sales tax increase in April. The Council on Economic and Fiscal Policy said the real gross domestic product will grow 1.2 percent this fiscal year instead of 1.4 percent estimated in January.

RBNZ increases its interest rate for a fourth time

As expected, the Reserve Bank of New Zealand increased its overnight cash rate (OCR) by 25 basis points to 3.5 percent. This was the fourth interest rate increase since February. In his statement, Reserve Bank Governor Graeme Wheeler noted that the economy is expected to grow 3.7 percent over 2014. "Global financial conditions remain very accommodative and are reflected in low interest rates, narrow risk spreads, and low financial market volatility. Economic growth among New Zealand's trading partners has eased slightly in the first half of 2014, but this appears to be due to temporary factors." The RBNZ was the first central bank from a developed nation to embark on a tightening cycle this year.

The RBNZ has an inflation target range of 1 percent to 3 percent. Governor Wheeler expects inflation to remain moderate even though strong output growth has been absorbing capacity. Wage inflation is subdued and reflects recent low inflation outcomes, increased labour force participation and strong net immigration. He expects average inflation to remain near the 2 percent mid-range target. He noted that the economy appeared to be adjusting to the monetary policy tightening, but he said it is now prudent that there be a period of assessment before interest rates adjust further towards a more neutral level.

Wheeler, who raised the possibility of currency intervention in May, said the exchange rate is unjustifiably high because it has failed to respond to a price slump in dairy products, New Zealand's largest export. In the past, one of the criteria the bank has set for currency intervention is that the kiwi's level is "unjustified." The New Zealand dollar or Kiwi has gained 6.5 percent against the U.S. dollar since the end of January, damping the price of imported goods.

Currencies

The U.S. dollar was up against all of its major counterparts including the euro, pound sterling, yen, Swiss franc and Canadian dollar. It was unchanged against the Australian dollar. The U.S. currency climbed to the highest level in a more than a month amid signs the U.S. economy is outperforming its major peers. Earlier in the week, the dollar rose to the highest in eight months against the euro as funding measures and monetary policies between the two economies diverge. The pound weakened after the Bank of England MPC minutes of its meeting held earlier this month indicated continued caution regarding a possible interest rate increase. The euro retreated after the July Ifo German business climate index, based on a survey of 7,000 executives, declined to 108 from 109.7 in June, marking the third straight monthly decline.

Reserve Bank of New Zealand Governor Graeme Wheeler is vigorously campaigning against the New Zealand dollar's value. The kiwi tumbled the most in 11 months Thursday after Wheeler said in his policy statement at the conclusion of the RBNZ's policy meeting that the currency's strength was "unjustified" and that he will wait before raising interest rates further. Wheeler has struggled for months attempting to talk the currency down to make it weaker and more export friendly and at the same time balance the need for higher borrowing costs to prevent a housing market bubble. While he has tried to talk down the currency in the past, strategists detect a hardening in his tone that may be the prelude to currency market intervention to curb the kiwi. Wheeler's statement followed the RBNZ's policy meeting, where he lifted the official cash rate by 25 basis points to 3.5 percent. New Zealand was the first developed country to boost borrowing costs this year since 2011.

Selected currencies — weekly results

Indicator scoreboard

EMU

June M3 money supply was up 1.5 percent on the year — its highest mark since November last year and this was enough to lift the 3-month moving average measure followed by the ECB from 0.9 percent in mid-quarter to 1.1 percent. Private sector lending put in a better performance with a 1.7 percent yearly contraction following May's 2.0 percent decline. Within this, borrowing by households improved a tick to minus 0.6 percent although, less promisingly, loans for house purchase were down 0.4 percent after a 0.3 percent decline last time. Still, at minus 2.3 percent, lending to non-financial corporations was up 0.3 percentage points from May. Lastly, borrowing by non-monetary financial intermediaries (excluding pension funds and insurance companies) climbed from minus 6.8 percent to minus 5.6 percent.

Germany

July Ifo business climate indicator dropped a surprisingly steep 1.7 points to 108.0, its third consecutive decline and its weakest reading since October last year. The latest drop reflected declines in both current conditions and expectations. The former posted a near-2 point slide to 112.9, only its second reversal this year but also its lowest reading in 2014 apart from January. Expectations have been trending south since February and July's decline to 103.4 was the fifth in the last six months and left the index at its poorest mark since October 2013. Among the major sectors, morale was down across the board, notably in retail, manufacturing and wholesale.

United Kingdom

June retail sales edged up 0.1 percent and were up 3.6 percent from June 2013. Excluding fuel, sales were down 0.1 percent but were up 4.0 percent on the year. June's headline increase was held in check by the non-food sector which posted a monthly 0.7 percent drop. Within this, clothing & footwear was down 1.7 percent, non-specialized stores 0.6 percent and the other stores category 1.3 percent. By contrast, household goods recorded a 1.9 percent gain. Non-store retailing was also up 0.6 percent and food purchases rose 0.3 percent.

Second quarter preliminary gross domestic product was up 0.8 percent on the quarter and 3.1 percent when compared with the same quarter a year ago. The annual growth was the best performance since the fourth quarter of 2007. The advance was also sufficient to move the level of real GDP 0.2 percent above its pre-crisis peak. As usual with the first estimate, the ONS did not provide any details of the GDP expenditure components. However, from the output figures it is clear that growth was dominated by a strong service sector where activity expanded 1.0 percent on the quarter after a 0.8 percent increase at the start of the year. Within this there were very healthy gains in distributions, hotels & catering (1.3 percent) and business services & finance (also 1.3 percent) as well as in transport, storage & communication (1.2 percent). Government was up 0.2 percent. Goods producing industries did not match this pace and a 0.4 percent quarterly increase in overall industrial production was little more than half its first quarter pace and, moreover, flattered by a 4.7 percent bounce in electricity, gas & steam. The key manufacturing category grew a relatively modest 0.4 percent. Elsewhere, agricultural output slipped 0.2 percent on the quarter and construction, somewhat surprisingly, was down 0.5 percent.

Asia/Pacific

Japan

June merchandise trade deficit was ¥822.2 billion, larger than the median forecast of a deficit of ¥688.0 billion. Exports were down 2.0 percent on the year. Analysts expected an increase of 1.1 percent. This was the second straight drop. Imports were up 8.4 percent, less than the median of 9.0 percent. It was the first increase in imports in two months. Exports to Asia were down 3.3 percent on the year but were up 1.5 percent to China. It was the 15^th straight increase in exports to China. Exports to the U.S. slid 2.2 percent for the second consecutive drop. Exports to the EU jumped 6.4 percent for the thirteenth consecutive increase.

June consumer price index was down 0.1 percent on the month and up 3.6 percent on the year. Excluding fresh food, the key core CPI was unchanged on the month and up 3.3 percent as expected on the year. A second core measure that also excludes energy slipped 0.1 percent on the month and was up 2.3 percent from a year ago. June core CPI that excludes the impact of the sales tax was estimated to be 1.3 percent — about the same as prior to the introduction of the increase in sales tax. Energy costs were up 9.6 percent on the year after increasing 10.1 percent in May. TVs jumped 8.0 percent after sliding 0.9 percent the month before. Electronics goods prices were up 8.0 percent after increasing just 3.0 percent in May.

Australia

June quarter consumer price index was up 0.5 percent as expected following a 0.6 percent increase in the March quarter. On the year, the CPI was up 3.0 percent after increasing 2.9 percent in the March quarter. The annual increase is the top of the Reserve Bank of Australia's inflation target range of 2 percent to 3 percent. The 2013 average for the CPI was just below 2.5 percent. The RBA's preferred measure, the trimmed mean, was up 2.9 percent on the year. The Weighted mean was up 2.7 percent on the year. The most significant price increases in the quarter were for medical & hospital services (up 4.6 percent), new dwelling purchase by owner-occupiers (up 1.6 percent) and tobacco (up 3.1 percent). These increases were partially offset by declines in domestic holiday travel & accommodation (down 3.8 percent), automotive fuel (down 2.7 percent) and telecommunication equipment & services (down 1.6 percent).

Americas

Canada

May retail sales were up 0.7 percent on the month following a stronger revised 1.3 percent increase in April. Compared with a year ago purchases were up 4.0 percent, down from 5.3 percent last time but only due to unfavourable base effects. Volume sales were not quite as robust, up 0.4 percent and 2.3 percent higher than in May 2013. The monthly advance in overall nominal sales reflected increases in seven of the eleven subsectors. Motor vehicle & parts were up 2.5 percent. Excluding this category sales were up just 0.1 percent (and volumes down 0.1 percent). Elsewhere there were notable increases in building material & garden equipment & supplies (3.5 percent), furniture & home furnishings (3.7 percent) and sporting goods, hobby, book & music (2.1 percent). Gasoline also saw a 2.0 percent bounce. On the downside there were monthly declines in food & drink (1.6 percent), electronics & appliances (1.7 percent) and in health & personal care (1.2 percent). General merchandise was off 0.5 percent.

Bottom line

Economic data and earnings reports were mixed last week. As expected, the Reserve Bank of New Zealand increased its policy interest rate for the fourth time since February. The IMF once again lowered its global economic forecast.

The pace of new economic data picks up this week. Investors will monitor the final July manufacturing PMI reports closely along with key unemployment data from the Eurozone and Japan. All investors will parse the FOMC's post meeting statement closely, looking for further policy clues. The week ends with the U.S. July employment situation report.

Looking Ahead: July 28 through August 1, 2014

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