For the moment attention is focused on the strength of the German economy, and the beneficial effects that will be felt elsewhere in the zone; and there has also been a relaxation of tension about debt defaults, after the rescue package agreed by the member countries, and the intervention by the ECB to support the weaker bond markets. The German export performance depends of the maintenance of strong growth in the global economy that may not be sustained; and the odds still suggest that one or more of the weaker countries will at least be forced to defer interest payments on its sovereign debt, and may even default. The latest improvement in the markets therefore seems likely to need further support from Wall Street if it is to be sustained. The best performance amongst the major markets over the past month had occurred in the UK market. The measures announced by the new Coalition government to reduce the size of the fiscal deficit have been well received by the market, despite the fact that they will slow down the pace of the economic recovery over the coming months; and the latest estimate of a 1.1% growth rate in the second quarter of the year suggests that the effects of the fiscal retrenchment might even be less than had been expected, and has removed most of the fears about the possibility of a move into a “double- dip” recession.
The improvement in sentiment amongst investors is therefore easy to understand. Even before the announcement of the estimate of growth in the second quarter of the year, there had been further evidence of an improving economic situation. The unemployment rate fell; retail sales volumes rose by 1%, the strongest monthly increase in almost a year; and the latest quarterly survey from the CBI reported that manufacturing output increased at its strongest rate since 1995.
The 1.1% estimated rate was well above most forecasts. It was the result of expansion in both the manufacturing and services sectors of the economy. But the most surprising figure was the estimated 6.6% rate of growth in the construction sector that accounted for around one third of the overall growth in the period. It has also produced considerable interest regarding the reaction of the Bank of England to these figures. The bank has previously been mainly concerned about the risk of slower growth, and had even considered at the last meeting of its Monetary Policy Committee “arguments in favour of a modest easing in monetary policy” because “prospects for gross domestic product growth had probably deteriorated a little over the month”.
The mood will have changed now; but the governor, Mervyn King, has recently indicated that there will be no early changes in policy as a result of one set of figures. The background factors affecting the market therefore remain. Short-term interest rates will remain low, and the economy is performing better than expected; but the austerity measures that are to be introduced, and especially the increase in VAT in January, will depress demand over the coming months. It therefore seems likely that the UK market, like the markets in mainland Europe, will need further support from Wall Street if the recent strength is to be sustained.
The Japanese market is lower over the past month. There has been further evidence that the pace of the recovery in the Japanese economy is weakening; andthe poor performance by the ruling Democratic Party in the recent election seems likely to lead to a period of political uncertainty that will make it difficult for action to be taken to reverse the trend.
The earlier decision to introduce measures to reduce the massive fiscal deficit was a major reason for the government’s poor election performance in the election, and may well be reversed; and the Bank of Japan’s action to try to increase the rate of bank lending, especially to smaller companies, also seems unlikely to have much of an effect on the economic situation. The background situation in Japan is therefore very disappointing, and this is reflected in the performance of the equity market. It seems unlikely that there will be any early improvement in the situation, and so the Japanese market weakness looks set to continue.
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