Financial Market

Interest rates for the Eurozone were today raised to 4.25%, the first Eurozone interest rate rise in twelve months, in a move aimed at tackling record levels of inflation which this week hit 4%.

Rising food and fuel costs resulted in the European Central Bank raising its interest rate, a move which is thought could further weaken the dollar which is currently at a two month low, and lead to further increases in the trading price of oil.

In anticipation of the ECB’s rate increase, oil hit new record highs today, with Brent crude topping $146 a barrel for the first time.

The interest rate increase comes amid concerns that the eurozone economy is slowing and there are further concerns that rate hikes could slow the economy further.

“Today’s ECB interest rate hike underlines the bank’s determination to bring inflation down, even amid plain evidence of slowing gross domestic product growth” - Jennifer McKeown from Capital Economics.

Within the eurozone it was Spain who announced figures that suggested it is heading for recession with it service sector showing significant signs of retraction.

Other leading banks have also warned that It also signalled that more interest rate rises could be on their way if world oil and food prices continued to rise.

The United Nations yesterday warned that the political unrest across the globe that is being spurned on by rising global food prices, could undo the progress that has been made in developing countries.

In the Port-au-Prince province of Haiti rioters took to the streets for the second day after UN peacekeepers had fired tear gas and rubber bullets at protesters to stop them storming the presidential palace.

Protester set tyres alight and looted stores as hungry demonstrators rioted amid price hikes in staple foods such as rice and beans, as well as hikes in fuel costs. Five people were killed in the riots as protesters dubbed their hunger “grangou klowox” or eating bleach, a phrase being used to describe the burning in their stomachs.

A net importer of rice and one of the poorest countries in the world, Haiti is being hit hard by the rise in global food prices where people have no more than £1 a day to live on. Rioters have been demanding that the government should scrap all taxes on staples, and have called for the resignation of the president.

Haiti’s president Mr Preval has spoke of the possibility of increased government subsidies on the production of staple foods, but whether this will placate rioters is unknown.

The president did make a public address stating “To those who are stirring up violence, I order you to stop because it is not going to solve the problem”. He has also ordered Halti police and the 9,000 peacekeepers in the country to halt all looting in the country.

The unrest seen in Haiti provides evidence of the destabilising effect that accelerated food inflation could have around the world. Global food prices have surged of late, brought on by increasing demand in rapidly expanding countries such as China and India, drought in grain producing Australia and new competition for plant based bio-fuels.

Since 2002 the UN estimates that global food prices are up 65%, with grain up 42% and dairy up 80% in 2007 alone.

The UN Food and Agriculture Organisation (FAO) said in a recent report that Burkina Faso, Cameroon, Egypt, Indonesia, Ivory Coast, Mauritania, Mozambique and Senegal have all seen unrest in recent weeks linked to food and fuel prices.

Oil jumped above $107 a barrel today after the continued conflict in Iraq led to saboteurs blowing up one of the countries two major export pipelines. The attack came amid the third day of Iraqi military operations, targeted towards loyal fighters of the Shi’ite cleric Moqtada al-Sadr in the town of Basra in the southern Iraq.

The explosion marked the first time since 2004 that the southern Iraqi supply route has been disrupted.

“Crude exports will be greatly affected because this is one of two main pipelines transporting crude to the southern terminals, we will lose about a third of crude exported through Basra,” - Oil Company official

In last Friday’s trading a commodities sell off saw oil take a sharp fall to below $100 a barrel, after record highs of $111.80 seen last earlier in the week, but todays rise is a further extension on the $4 gains made yesterday after a report showed lower than expected petrol stocks in the US.

US crude was up 43 cents to $106.33 this afternoon, after peaking at $107.70 earlier in the day. Any gains that were to come on the back of increasing conflict in Iraq were limited by a strengthening dollar which also showed gains after the FED eased recession worries.

The dollar gains were also backed by figures released which showed US jobless benefit claims fell by 9,000, with the greenback managing to regain some lost ground. In early trading it saw a rise of 0.6% to %1.5757 against the euro and a rise of 0.9% against the Yen.

Monday saw heavy losses to European stocks triggered by continued global gloom, but in early trading today showed signs of recovery after a positive session for Asian stocks. The FTSE 100 index was up 2%, the Dax up 1.8%, and the Cac 40 in Paris up 1.9% in early trading this Tuesday morning.

Asian markets also closed predominantly higher with the Nikkei closing 1.5% up, the Hang Seng up 1.4% and the Sensex in Mumbai up 2.0%. Shanghai’s main index did however fall 4% amid fears that Beijing will take action to slow her economy.

Mondays trading marked a wild session which many believe is a culmination of the several events that have rocked investor’s confidence in the past week. The collapse of respected US investment firm Bear Stearns, with its subsequent sale to another Wall Street player JPMorgan Chase at the rock bottom price of $2 a share, followed by emergency liquidity actions undertaken by the Federal Reserve on a Sunday night, and a continued confidence crisis in worldwide credit markets, together led to major European markets recording huge losses in Mondays trading.

The US stock market however didn’t record such losses thanks to bargain hunters taking advantage of the price tumbles, particularly in blue chip and technology sectors.

Shares in Bear Shares had fallen 84% on Monday to $4.31 whilst those of JPMorgan increased by 10% to $40.31.

“The Fed is treating Bear as if it were a large failed bank,” - S&P Economics.

As a result of the collapse many are predicted a prolonged global financial crisis, branching wider and deeper than previously predicted, marking a stark shift in opinion that could magnify any potential effects on world wide economies.

The action made by the FED on Sunday marked its first weekend move in nearly 30 years, making a quarter point cut and announcing it will lend to the twenty primary dealers that buy Treasury securities directly from it, a move not used since the Great Depression.

Largely responsible for the cut price sale of Bear Stearns, the FED will also finance the deal by providing up to $30 billion to JPMorgan.

Many are also awaiting further news today from the Fed, as they are widely expected to cut its benchmark interest rate by a full percentage point to 2.0% as it battles to restore confidence and boost the economy. With continued point cuts like this it could very much be the case that we will see the dollar as a free currency, the first currency to do so since the yen.

Toady China has reported an ii year high inflation high increasing pressure on Beijing to increase interest rates.

After an unusually severe winter and freezing temperatures destroying crop yields, food prices have been pushed up 18.2% in January, leading to an overall inflation rise of 7.1%. The price of pork alone has risen 58.8% in the last twelve months.

Non-food inflation rose only slowly, hitting an annual rate of 1.5%, the figures showed.

In the last three weeks China has had one of the coldest winters on record, and coupled with expected price rises in the run up to the Lunar new year, inflation has risen to its highest level since September 1996, when it was at 7.4%.

The weather that has been experienced in China has also affected power supplies and transport networks.

“The CPI was mainly driven up by factors including the severe snow disaster that ravaged more than half of the country,” the official Xinhua news quoted Yao Jingyuan, the chief economist of the statistics bureau, as saying.

At the same time the country experiences record high inflation Beijing has also been taking steps to slow the growth of China economy which expanded at a 13 year high of 11.4% in January, also increasing prices.

Over the past thirteen months Beijing has raised interest rates six times and told reserve banks to put eleven times more money into reserves. Similar actions are also expected over the next year to control spiralling prices.

“This is not the peak. The peak will probably be in February because China suffered more in February from ice and snow storms,” Chen Xingdong, a senior economist at BNP Paribas in Beijing, said.

For communist China inflation is a particular concern, sparking fears of social unrest, and with the general consensus saying the worst is not over, Beijing is no doubt got radical plans up its sleeves.

Another key sign that the inflation problem is worsening was data released Monday showing China’s producer or wholesale prices were up 6.1% last month from a year earlier, the fastest increase in over three years.

“Energy costs, raw materials, mineral products are all shooting up. Labour costs are also increasing. These have to translate into inflation in one way or another,” said BNP Paribas’s Chen.

With costs of raw materials rising as well as food and energy prices, the countries vast export industries are also in danger of becoming more expensive to international markets. If this happens we could very well see China contributing more towards world inflation.

On Thursday the Bank of England cut interest rates by a quarter of a percentage point to 5.25%, the second cut that the BoE has made in three months.

The monetary policy committee that votes on interest rate changes, voted to reduce the BoE’s interest rate in the face of the countries economic slowdown. The quarter point reduction was widely tipped following the decision of the FED to cut rates by three quarters of a percent in January in an attempt to stave of economic recession.

The quarter point cut did not however match that of the FED due to increasing food and fuel prices pushing inflation above the two percent target the BoE sets.

According to David Kern, “Global and domestic conditions have worsened since the MPC met last month.”

Since the last meeting of MPC members the situation had changed to a point where a rate cut was now urgently needed, and a further cut to five percent may be planned as part of a two tier rate reduction. A half point cut in one meeting may well have looked like a panic move.

With the rate reduction made yesterday cost for consumers and businesses who rely on credit will be cut, boosting confidence and act as a catalyst for economic growth. At the same time however the cut will hit savers.

Following the quarter point rate cut the BoE rejected calls from a group of influential MP’s to publish a breakdown of the voting of the MPC with each meeting.

The Treasury Select Committee recommended on the ten year anniversary of the MPC that financial markets would benefit if they could see the support for any one decision.

The BoE rejected this idea saying rate setters publish the logic behind any particular vote two weeks after the decision on interest rate changes.

‘Releasing the vote at the time of the decision runs the risk of encouraging media speculation on the reasons for an individual’s vote and increases the simple-minded tendency to portray members as ‘hawks’ or ‘doves’,’ the BoE said.

Leaked minutes today confirmed that the Bank of England’s Monetary Policy Committee voted 8-1 in favour of keeping interest rates on hold in January, although the Bank of England is still widely tipped to make a quarter point cut to 5.25% next month.

The leaked minutes demonstrate the Banks reluctance to follow suit after the FED’s three quarter point cut on Tuesday, with increased concern about the risk of spiralling inflation in the UK.

A reluctance to follow suit not only being shown by the Bank of England, but by other European central banks as well. Suggestions that European central banks are also reluctant to slash interest rates in a similar style to the FED created knock on effects in Wednesdays trading which saw US and European stocks fall further.

The worry is that slower economic growth will hurt corporate earnings, and stocks fell accordingly across all sectors. With Central Banks ruling out immediate rate cuts to boost economies, it means that slowed economic growth could be the trend for early 2008 as the US and UK fight to stave off recession.

“The uncertainty about corporate earnings growth in 2008 has risen, and not only in the financial sector.” said Matthias Schellenberg, managing director at ING Investment Management.

The Federal reserve today cut interest rates by three quarters of a point to take interest rates to 3.5%, 90 minutes before US trading opened. The dramatic cut was drastic action taken by the FED in order to stop markets falling after Europe and Asia recorded record losses on Monday, when US markets were closed.

The cut failed to work however with US markets recording sharp falls when Wall Street opened for Tuesday trading. Throughout the course of Tuesday trading other markets had closed even further down on yesterday, indicating the US would too open down. The FTSE 100 briefly rallied upon news of the FEDs actions after falling 3% early on, only to fall back again later on.

The actions of the FED are a clear indication of its concern, and weren’t meant to meet until next week, making this cut something of a panic move.

The underlying factor is that the real economy has not changed much in the last week, and as such the FED would not have to act now to make a decision on interest rates. What has ushered this move is financial market developments that are threatening to impact the real economy.

In essence if financial markets panic about what is going on in the real economy it can affect the real economy, leading to a nightmare for economy policy makers, which is a feedback mechanism of the markets being spooked by the economy, feeding back into the economy, sending everything into a tail spin.

Therefore the rate cut by the FED is designed to prevent this tail spin, but at the same time destroys confidence.

For mechanical reasons rate cuts will make it easier to borrow money and buy shares, and therefore can be used to prop up stock markets, but when market is determined to fall it is difficult to stop it. This is a similar pattern to drastic rises what a quarter point rise tends not to have an effect on growth, another cut wont solve the current downturn, but this downward phase for many is seen as a correction of the upward phase seen over recent years.

It is hard to steer and control financial markets, and central banks will say it is there doctrine not to control stock markets but to stop the economy going into a spin and if that means further rate cuts then so be it.

The implications of the FEDs cut on the UK are expected to be minimal. The UK are based in sterling and the Bank of England shouldn’t feel any pressure by the Fed to cut UK interest rates accordingly. Central banks are however looking to perceive that they understand and are in control, which in turn does put some pressure on the Bank of England to act, making the expected cut next month even more of a certainty. A FED style out of hours meeting is unlikely though unless further chaos continues in the market.

In terms of the global volatility of markets witnessed over the past two days many do expect a bumpy year although not on the same levels, and as such many experts expect markets to settle down.

But it is important to understand that this market downturn is not like 9/11, this market downturn has an economic underpinning where world markets are trying to adapt their view of the American economy. World markets have been late in understanding the crisis facing the American economy and its decline over the past year. At the moment world markets are correcting itself in a sense, a process which can be messy. The Economy will settle down and markets will learn to live with where the economy will settle down, which in turn will bring an element of stability back.

Global stock markets have tumbled today; with European indexes recording some of the biggest loses in recent years, and worst early January trading since records began on the back of growing fears of recession hitting the US.

Indexes in Europe fell as much as 7% after huge a sell off in Asia leading to the biggest single days trading losses in recent years. The selling started in Sydney where stocks fell 3% recording their 11th straight decline, spurring the way for Asian markets to follow suit.

Hong Kong’s Hang Sang index recorded its biggest fall since 9/11 falling 5.5%, with losses of between 3% and 7% seen in India, China, Britain, France and Germany.

In afternoon trading, the Dow Jones Euro Stoxx 50 was down 5.7 percent. The CAC 40 index in Paris was down 5 percent, having fallen more than 7 percent at one point. The Dax 30 in Frankfurt was down 6.25 percent, and the FTSE 100 in London was down 3.7 percent.

US markets are shut today due to public holiday, but more losses are expected tomorrow after an announcement by President Bush on a $145 billion stimulus package to encourage more consumer spending failed to lift markets on Friday.

Many are of the opinion that the stimulus package plan announced by President Bush may not be enough to prevent a recession, and investors will find it hard to argue that recession will not affect world markets after today’s trading.

“Investors in Asia have been in a state of denial about the possibility of a recession in the United States. But now there’s no debate about it.” - Adrian Mowat, chief strategist for JPMorgan in Asia

And there may be even more losses in Asia still to come, particularly as banks report the fallout from their investments in the United States mortgage market.

The US dollar fell against both the Euro and the Yen and marked a two and a half year low on the Swiss Franc on Wednesday after figures were released showing consumer prices for December in the US were higher than forecasted, increasing concerns regarding inflation at a time of slowed economic growth in the US.

Disappointing retail figures for Decembers have also suggested that the US economy might be facing deeper problems, and falling global stock markets have also fuelled speculation that the Fed could cut rates by as much as 75 basis points soon.

Investment bank Goldman Sachs has already predicted that the US economy will fall into recession in 2008, and December’s retail data will confirm the worst for many analysts’.

As consumer spending accounts for two-thirds of the US economy, the retail figure for December could go a long way to supporting that Goldman’s fears are in fact correct

The high December prices coupled with a slowing economy however, leaves the Fed in a delicate position. Fed chairman Ben Bernanke’s has made comments suggesting that the central bank is willing to take “substantive additional action” to maintain growth which leads many to hold expectations of at least a half percentage point cut in the Fed’s benchmark interest rate, but lower rates cut the attractiveness of dollar-denominated securities and reduce demand for the dollars to buy them.

Citigroup has also reported its first quarterly loss since its establishment in 1998, and being the first bank to release its results for the last three months of 2007, its figures are seen as an indication of the effects the crisis in the sub-prime mortgage sector will have on the rest of the banking sector.

With a further decline of the Dollar brought on by figures supporting more weak bank earnings, inflation could rise further leading many to question and the Feds aggressive rate cuts.

“A rise in the core (inflation) to 2.4 percent could start to question the Fed’s presumed path of aggressive rate cuts — sending equities sharply lower,” said ING in a note to clients.