The A flurry of upbeat US indicators suggest the economic climate is improving, which should help Wall Street shake off its lethargy Weak export orders continue to weigh on An improvement in manufacturing orders signals a recovery in the euro zone, but only a tepid one As news broke on 7 July of the four suicide bombings on the London Underground and a This apparent fortitude is explained by the fact that those industries likely to be most affected by the bombings – the transport, and leisure and hotels sectors – make up only 4 per cent of the capitalisation of the The impact of the bombing on the The devastating outbreak of foot-and-mouth disease amongst livestock in February 2001 and the Nonetheless, with economic growth at its slowest rate since 1993 and the manufacturing sector officially in recession, the UK economy is not in the best shape to weather too much of a shock. Economic indicators such as business confidence and retail sales have improved a little over the past few weeks, but it remains too early to gauge whether the consumer slowdown has run its course, particularly in the aftermath of the The last time the Monetary Policy Committee (MPC) met, four of the nine-strong committee voted for a cut. Moreover, the consumer slowdown has turned out to be more severe than even the most ardent hawks on the MPC, concerned about the overheating housing market and the ballooning of consumer debt, had expected. The outlook for The modest improvement in the economic climate is outweighed by weak investor sentiment. Investment analysts, for example, have been downgrading profit forecasts over the past couple of months, while in most other markets they continue to raise them. Moreover, foreign investors continue to favour markets elsewhere. The pound has also suffered from a sharp downturn in sentiment, partly as a result of the Over the past few months the Business confidence has also stabilised and new manufacturing orders have surged, even ignoring Boeing’s best ever month for new aircraft orders following the Although this inventory drawdown has detracted from growth over the past few months, the inventory overhang should be less of a drag on growth in the coming months. In addition, underlying retail sales – ignoring sales at petrol stations – have accelerated modestly. The better news does not suggest that the Concern about the outlook for Despite the improved economic news, the 10-year government bond yield at 4.2 per cent remains almost 0.5 per cent lower than the level at which it stood when the Federal Reserve first began raising interest rates in June last year. With bond yields remaining very depressed, equities continue to look better value, as do government bond markets elsewhere. Nevertheless, sentiment towards equities is still a little soft with company directors in particular still preferring to sell shares in their own companies. The US dollar has seen a dramatic turnaround in its fortunes since the beginning of the year. With the Federal Reserve expected to continue raising interest rates to at least 4 per cent by the end of the year, the currency should continue to rally, especially given the current strength of sentiment. A little unusually for Over the course of 2003 and 2004, The bright spot continues to be household spending. It has been bolstered by an improvement in the labour market as employment reached its highest level in three-and-a-half years. However, with industrial production now shrinking, employment growth is likely to wane. Of course, if export orders were to pick up sharply, employment growth could accelerate still further. For the moment the economic climate still looks a little patchy, although the Euro zone poised for uninspiring recovery The euro zone recovery has never really taken hold. Last year the euro zone grew by 1.7 per cent and this year economists, on average, expect the region to grow by a meagre 1.3 per cent. French and German unemployment, at 10.2 per cent and 11.7 per cent of the workforce respectively, is the highest in more than five years. Despite the weak climate, the European Central Bank (ECB) has kept interest rates unchanged since May 2003. One reason for the ECB’s reluctance to lower rates has been the extent to which inflation remains stubbornly above its 2.0 per cent target. Nevertheless, underlying inflation ignoring energy prices is only 1.3 per cent, suggesting that inflationary pressures across the region are not a great threat and that policymakers at least have no pressing need to raise interest rates.However, there are signs that activity is beginning to pick up. French and German business confidence, for example, has been recovering from its trough in May. Export orders in particular are beginning to improve, suggesting the euro’s fall is helping to ease at least some of the region’s woes. The weak link continues to be household spending. French household spending, for example, has begun to fall and business surveys across the region suggest confidence amongst retailers has not matched the recovery in confidence amongst manufacturers. Therefore, although the economic environment appears to be improving across the region, the recovery looks set to remain half-hearted for the time being. Nevertheless, the prospect of a fairly tepid recovery should not be too much of an encumbrance to European stock markets. After all, the weak economic climate has not kept the region’s markets from rallying strongly so far this year. The French and German markets have risen by 15 per cent, and even Despite their out-performance in 2005 — the The main factor in their favour, though, is the strength of sentiment. Investment analysts are for the most part revising profit forecasts higher and foreign investors continue to invest heavily in euro zone equity markets. While sentiment towards European stock markets is very upbeat, the same cannot be said of the euro. Moreover, the likelihood that euro zone interest rates will remain stuck at 2 per cent even as US interest rates reach 4 per cent, means that the interest-rate outlook continues to weigh on the currency.
Market background
Improvement in economic climate to help Wall Street
Japanese exporters struggling