Global Markets Weekly - 7th April 2008

• After its latest cut, the Fed will probably wait to see the impact of its earlier action...
  As expected, the US Federal Reserve (Fed) last week cut rates by 25 basis points, bringing the Fed funds rate to 2%. The accompanying statement gave a clear signal that the Fed now wishes to pause to assess the impact of its rapid 325 basis point reduction in policy rates. The current cycle of interest rate easing started only last September. So, given the lags with which monetary policy operates on the real economy, it is unlikely to have had anything but a small fraction of its total impact.
• …and of the US tax rebates....
  As well as gauging rate cuts’ impact so far, the Fed will wish to see the effect of tax rebate cheques, which began to be posted out last week. The success of this recession-limitation measure depends entirely on how much of the rebates households choose to spend rather than save or, more likely, to repay existing debts. Policy-makers are aiming to repeat the success of the tax rebate stimulus of 2001, which prevented a single quarter of negative growth in US consumer spending during that year’s recession.
• …whose impact is unlikely to prove as stimulative as in 2001.
  The speed with which legislators have acted this time around is encouraging. In the past, most recession-prevention measures have been passed after the recession has already ended. However, the circumstances facing US households now are very different to 2001 – with credit conditions being dramatically tightened and the prospect of increases in tax rates over the coming years (as both Democratic presidential contenders propose),rather than the 10-year tax cut package that accompanied the 2001 rebate.
  
• The Fed will be expecting worsening activity data but falling inflation.
  So now is a good time to pause and watch the reaction of the economic data. This pause could well turn out to be the trough in the Fed funds rate; that would certainly be the Fed’s preferred outcome. Ultimately, however, the Fed’s actions over the rest of the year will be data-dependent. The Fed will clearly be expecting a continued worsening of lagging indicators of economic activity, most especially unemployment, and some improvement in inflation trends as the reduction in growth during late 2007 starts to take effect. So it will be critical to gauge how far these indicators are in line with the Fed’s expected pattern.
• The UK is following the US's path, with house prices set to fall further...
  In the UK, last week’s numbers suggested that the economy is running along similar lines to the US, though perhaps some months behind on house price declines and their economic impact. Figures from both the UK’s largest mortgage lending bank and its largest building society now show house prices declining on the year. Leading indicators of house prices – such as mortgage approvals and the Royal Institution of Chartered Surveyors price survey – point to further declines to come.

• …and much of the eurozone is just as vulnerable to housing weakness.
  Meanwhile, Spanish data showed retail sales now declining at 8.7% year on year – a warning that growth in many regions of the eurozone is as exposed to house price declines and tightening credit conditions as the US and the UK. In France, the INSEE consumer confidence survey has declined rapidly over recent months, suggesting that the current relatively robust 3% year-on-year growth in French retail sales is likely to decline over the coming months.

• So we expect further rate cuts in the UK and Europe. So, while the Fed is nearing the end of this rate-cutting cycle – and indeed may have already reached it – the UK and Europe seem to have further to go.

Indices, Interest rates and Inflation

	Close 05-May-08	1 Week%	1 Month%	3 Months%	YTD %
FTSE ALL Share	3,163	2.0	4.1	5.5	-3.8
FTSE 100	6,216	2.1	4.5	5.9	-3.7
S&P 500	1,407	0.8	2.7	5.3	-4.1
Nasdaq Composite	2,464	1.6	3.9	6.7	-7.1
DJ Stoxx (Europe)	371	1.5	2.8	4.6	-10.5
Nikkei 225	14,049	1.1	5.7	2.2	-8.2
Hang Seng	26,184	2.0	7.9	5.5	-5.9

Official Rates (%)				Inflation (%)	Rate announcement
	Current	Jun-08 Forecast	Sep-08  Forecast	Current	Next Date
US (Fed Funds)	2.00	2.00	2.00	4.0	25-Jun
UK (Base rate)	5.00	5.00	4.75	2.5	08-May
Euro-zone (Repo Rate)	4.00	4.00	3.75	3.6	08-May
Japan (Call rate)	0.50	0.50	0.50	1.2	19-May

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