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Another interest rate hike in May now looks almost certain.
Factory gate inflation – the rate at which manufacturers are hiking prices – jumped to an annual rate of 2.7% in March, compared to just 2.3% in February, much stronger than expected.
But what’s more, as Money Morning was heading to press this morning, consumer price inflation followed suit, leaping to 3.1%. It means Mervyn King will have to get his crayons out – more on that in tomorrow’s edition.
Meanwhile all the talk in the papers is of a $2 pound and what that means for us here in the UK – but we’re more worried about what it means for the US economy…
Producer price inflation came in much higher than expected yesterday, driving up expectations for an interest rate hike next month, and also pushing the pound higher. Sterling is already around a 14-year high, trading as high as $1.9939 yesterday – this morning’s papers are full of talk about the $2 pound, and it’s something that could well happen – perhaps even by the time you read this today.
It’s not just about the apparent strength of the UK economy. The pound is also being driven higher by the carry trade – where investors borrow in a low-interest-rate currency (mainly Japanese yen) and invest in a higher-yielding currency, often New Zealand dollars, but also including sterling or dollars. If a rate hike goes ahead next month, the UK will have higher interest rates than the US for the first time in over two years. That will make it even more attractive to carry traders – and will also put more pressure on the dollar.
There are plenty of downsides to a high pound, of course – it can give an odd sense of nationalistic pride to some, and might be great if you plan to visit the States and haven’t bought your holiday money yet, but it’s not so good if you’re a shareholder being paid dividends in dollars.
But it’s also more bad news for Federal Reserve chief Ben Bernanke. The weaker the dollar becomes, the more inflationary pressure builds in the US economy as imports in particular become more expensive. This is at a time when an uncertain investment world is relying on the Fed to slash US interest rates if the American economy shows further signs of weakness as the problems in the housing market unfold further.
As global rates rise, as it seems they will, and the US yield becomes relatively less attractive, that inflationary pressure will continue to mount. It looks like the markets won’t be able to rely on a ‘Bernanke put’ to bail them out of trouble this time – and that means that the next US recession could hit harder and deeper than any we’ve seen in quite some time.
On another note, it’s been revealed that a Saudi billionaire, Maan al-Sanea, has snapped up 3.1% of banking giant HSBC. Al-Sanea, described as “low profile” by The Times, took advantage of the slump in HSBC’s share price that followed its recent profit warning amid the collapsing US sub-prime market.
Of course, MoneyWeek readers will already be aware of HSBC’s attractions – our own Paul Hill tipped it recently as being among his favourite stocks for the next five years. Subscribers can read the article here: Five shares to help you retire rich.
Paul also runs his own very successful email share advisory service – you can find out more about it by clicking here: Paul Hill.
Turning to the stock markets…
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London’s blue-chip index hit a six-and-a-half year high yesterday as both the banking and mining sectors put in a strong performance. The FTSE 100 climbed 53 points to achieve a close of 6,516, its highest since August 2000. The broader indices were also up. Rising metals prices helped miners Vedanta Resources and BHP Billiton to the top of the FTSE leaderboard, along with financials Bradford and Bingley, Alliance and Leicester and Royal Bank of Scotland, who benefited from M&A news in the sector. For a full market report, see: London market close
Stocks ended the day higher across the Channel as well. In Paris, the CAC-40 closed 72 points higher, at 5,861, with M&A-fuelled gains in the banking sector also providing support. In Frankfurt, meanwhile, the DAX-30 added 125 points, ending the day at 7,338.
On Wall Street, US stocks rallied yesterday as investors welcomed strong earnings from Citigroup and a $25bn buyout of educational lender, Sallie Mae. The Dow Jones jumped 108 points to a close of 12,720. The tech-heavy Nasdaq added 26 points to end the day at 2,518. And the S&P 500 was up 15 points at 1,468.
However, in Asia the Nikkei gave up some of its recent gains as it fell 100 points to 17,527. In Hong Kong, the Hang Seng added 18 points to close at 20,751 today.
Crude oil was stable at $63.61 a barrel this morning, whilst Brent spot had climbed to $66.98 in London.
Spot gold had fallen to $688.90/oz in Asia trading, down from $690.90 in New York late last night. Silver had crept up to $14.06/oz.
And in London this morning, retail giant Tesco posted a a forecast-matching underlying annual profit of £2.55bn – a 13% increase – despite tougher trading conditions for the sector. The company also announced that it is to double the amount of cash which it returns to shareholders. Tesco shares hit a new high of 467-3/4p in early trading.
And our two recommended articles for today…
Funds: why big isn’t beautiful
– As this year’s round of Isa investments has shown, Britons are becoming increasingly disillusioned with the big name brands, says Merryn Somerset Webb. If you too are fed up with mediocre returns, click here to find out where the really attractive funds can be found: Funds: why big isn’t beautiful
Are investors eyeing the wrong indicators?
– That stronger-than-expected payroll data saw the dollar rally and bond prices fall is testament to the fact that traders have little sense of what is truly important. For more from Paul van Eeden about how markets have reacted to recent economic data – and the economic issues investors should really be concerned about, read: Funds: why big isn’t beautiful