Inflation expectations in the limelight

from www.nytimes.com

June 11, 2008
Inflation Worries Unsettle Global Markets
By MATTHEW SALTMARSH and KEITH BRADSHER
PARIS — Fears of rising interest rates in Europe and the United States and their effect on already faltering consumption dragged share prices lower in Europe on Tuesday after a sell-off in Asia.
In afternoon trading, the main European indexes had pared earlier losses of over 1 percent but remained lower, taking their cue from Asia.
Stock-index futures in New York also dropped amid mounting concern that the Federal Reserve will raise borrowing costs to fight inflation.
Chinese stocks fell 8.1 percent on Tuesday, their biggest single-day drop in nearly 16 months, leading a downturn in Asian stock markets.
The plunge in the Shanghai and Shenzhen markets followed an increase in Chinese bank reserve requirements, heightened worries about food and oil prices, and fears about exports to the United States.
Comments late Monday from the chairman of the Federal Reserve, Ben S. Bernanke, who said that threats to the American economy had diminished and that the central bank would “strongly resist” inflation pressure, added to the sense in the market that rates in the United States have hit a low point in this cycle.
The remarks, coupled with a signal last week from the president of the Europe Central Bank, Jean-Claude Trichet, that borrowing costs in the euro zone could rise as soon as next month, have led to fears that consumer activity will weaken further.
“The mood has changed quite dramatically in the last two or three weeks,” said Roger Cursley, equity strategist at Investec, a banking group in London. “Central banks are focusing on inflation, and seemingly they have put worries about the effects of the credit crisis behind them.”
The expectation of higher rates, just as consumers struggle to adapt to higher oil and food prices, has led to a raft of downward revisions to growth estimates in the West from institutions like the Organization for Economic Cooperation and Development. The OECD said last week that growth among its members would slow to 1.8 percent this year and 1.7 percent next year, compared with its previous forecast of 2.3 percent in 2008 and 2.4 percent in 2009.
That in turn is lowering the expectation among analysts for earnings growth, particularly among banks, retailers, homebuilders and leisure stocks. Those stocks with more exposure to emerging markets, particularly food and tobacco stocks, and those that benefit from rising prices, like utilities, appear less vulnerable to the downturn.
In London, the FTSE 100 was down 0.6 percent to 3,576.11 points in early afternoon trading. The CAC-40 was down by the same amount at 4,769.76 in Paris and the broader Stoxx 600 also shed 0.6 percent, to 306.99. In Frankurt, the DAX was off 0.8 percent to 6,760,29.
Among individual stocks, ABB, the world’s largest builder of power networks, lost 2.3 percent to 31.56 Swiss francs. Tesco, the giant British retailer, dropped 3.2 percent to 389.1 pence after higher food and energy prices curbed its revenue.
Among American stocks traded in Europe, Bank of America sank 24 cents to $29.37 in Germany. Texas Instruments fell 57 cents to $30.76 in Germany after predicting second-quarter sales that met analysts’ forecasts.
In Asia, Industrial and Commercial Bank, the largest Chinese lender, slumped 8.4 percent to 5.38 yuan. Shanghai Pudong Development Bank dropped 10 percent to 25.75 yuan.
Elsewhere in the region, the Hong Kong stock market fell 4.1 percent; the Nikkei stock market index in Tokyo dipped 1.1 percent; the South Korean market declined 2.1 percent; the Taiwanese market was down 2.5 percent and the Australian stock market fell 2.8 percent.
Stock markets in mainland China and Hong Kong had been closed on Monday as a continuation of the Dragon Boat Festival on Sunday.
Economists attributed the steepness of the Chinese market’s plunge to broader worries among investors about how far the Chinese government will go to slow the economy to prevent food and oil prices from triggering a broader rise in inflation.
Chinese markets have lost 45 percent of their value since setting a record in October during a period of feverish speculation when many small investors began buying stocks for the first time.
The People’s Bank of China, the country’s central bank, announced on Saturday that it would raise the proportion of assets that banks must hold as reserves by a full percentage point, in two equal steps on June 15 and June 25. The increase — the fifth this year — tightens monetary policy by leaving banks with less money to lend.
“People can’t see the end of inflation,” said Stephen Green, the head of China research in the Shanghai office of Standard Chartered. “People are worried about the government having to continue to tighten.”
China is scheduled to announce on Thursday its statistics for consumer price inflation in May. During trading hours on Tuesday, news wire services cited unidentified Chinese officials as saying that the inflation rate was 7.7 percent; that would represent a decline from 8.5 percent in April, but would still be well above the rate of 5 percent that Chinese officials have described as the maximum they can tolerate.
Officials at the National Bureau of Statistics in Beijing could not be reached on Tuesday evening for comment.
China depends fairly heavily on exports, which have already slowed along with growth in the American economy.
Weaker growth in the United States could further reduce demand for the Chinese electronics, clothing and other products that already crowd the shelves of American stores.
China’s current account — the broadest measure of trade in goods and services as well as remittances and overseas investment returns — reached 11.3 percent of its entire economic output last year. Together with massive currency market intervention to slow the rise of the Chinese currency against the dollar, the current account surplus was a central reason why Chinese foreign exchange reserves grew by a record $462 billion last year.
Keith Bradsher reported from Hong Kong and Matthew Saltmarsh from Paris.