“Monetary policy around the world may have been too accommodative.”
With his traditional understatement, the Bank of England Governor Mervyn King has put his finger on the problems besetting global stock markets.
The head of the UK’s interest rate-setting committee was acknowledging that strong global economic growth in recent years might have had something to do with the tidal wave of cheap money flowing from the world’s central banks over the same period.
And now that banks around the world are tightening up, markets are feeling the pain. The bad news is that the BoE’s top man reckons there’s plenty more discomfort to come…
“So far we have seen little more than a modest correction to the prices of a wide range of assets that had risen sharply over the previous two years,” says Bank of England Governor Mervyn King.
The correction may not feel particularly modest to anyone who has bought into almost any stock market during 2006 so far. The FTSE 100 is now down 10% from its April peak, the Nikkei 225 has dropped nearly 20% and the Dow Jones has lost around 8%.
And emerging markets are even worse. India’s Sensex index has fallen 28% from its peak, while Brazil’s Bovespa has shed 22%.
So are the falls set to continue?
Regular readers will remember we published a piece from RH Asset Management a few weeks ago, where the group named four key turning points that could signal the return of a long-term bear market.
Two of the indicators – the Dow Jones falling below 11,000 and the Philadelphia Housing Index falling below 225 – have already been breached. And yesterday, the third indicator – the FTSE 100 falling below 5,500 – almost toppled, with the index falling as far as 5,467 during the session.
The fourth indicator is still standing – but if the current stock market carnage continues, it won’t be for long. You can find out what it is, and what these signals mean for global stock markets, by clicking here: Four bear market signs to watch out for
So why are interest rates heading higher now? The main problem is that inflation figures keep coming in higher than expected.
Higher water, gas and electricity bills pushed UK consumer price inflation up an annual rate of 2.2% in May, from 2% in April. The Bank of England’s main job is to keep inflation within a percentage point either side of its 2% target.
The reading was above most analysts’ expectations of 2.1%. Of course, that measly 2.2% annual rate still bears no resemblance to almost any normal person’s experience of the cost of living. As we’ve been pointing out for months now, that’s because the costs of things that people need – like water, gas and electricity – are rising, while the costs of non-essentials – particularly electronics goods – haven’t risen as rapidly, or have even fallen.
The Independent has noticed this too, and rather handily produced an alternative cost-of-living index. This strips out non-essential spending, and also includes things the Government would rather ignore – like council tax, for example.
Going by the Indy’s index, inflation is actually running at about twice what the CPI measure suggests it is. And people are starting to notice. The general public now expects inflation to hit 2.8% during the coming year.
If people expect prices to go up, they expect their wages to rise to match them. That makes Gordon Brown’s continual claims that he wants to keep public sector pay rises to an annual 2% for the next few years seem even more unlikely.
The other big worry that Mr King brought up was that rising inflation in China may impact on the UK. “Even in China, with its growing manufacturing base and large pool of labour, some indicators are showing upward pressures on export prices. And in turn that is raising our import prices.”
UK import price inflation, excluding oil prices, hit a 10-year high of 3.6% in April, writes Chris Giles in the FT. “Few [commentators] are now brave enough to believe that the world can assume import prices will continue to fall. If they start to rise at the rate of domestic services, the Bank of England will soon have an inflation problem on its hands.”
We wrote about this issue in Money Morning last week. If you missed it, you can read it here: Why China may soon ditch its biggest export – deflation
With even more inflation data due in the US later today, one thing’s for sure – we’ve not seen the last of the volatility yet.
Turning to the wider markets…
The FTSE 100 slumped, losing 101 points to close at 5,519. Higher-than-expected inflation data hurt sentiment, while plunging metals prices hammered mining stocks. Kazakhstan-based copper miner Kazakhmys was the main faller, down 7% to 948.5p. For a full market report, see: London market close
Over in continental Europe, the Paris Cac 40 fell 105 points to 4,617, while the German Dax dropped 103 to close at 5,292.
Across the Atlantic, US stocks took another tumble. US producer prices rose 0.2% in May, but core price inflation rose 0.3%. The Dow Jones Industrial Average fell 86 points to 10,706, while the S&P 500 plunged 12 to 1,223. The tech-heavy Nasdaq shed 18 to 2,072, its eighth losing session in a row.
Over in Asia, markets rallied. The Nikkei 225 added 90 points to 14,309. Stocks relying on domestic demand were the main gainers, with Japan’s second-largest retailer Aeon posting a 3.7% rise.
This morning, oil continued to fall in New York, trading at around $68.25 a barrel. Brent crude was also down, trading at around $65.50.
Meanwhile, spot gold was down sharply, after falling as low as $543 an ounce, before rebounding to trade at around $568 this morning. Silver was also lower, down to $9.47 an ounce.
And in the UK later this morning, Associated British Ports has agreed to be taken over by a consortium including US investment bank Goldman Sachs. The price of 810p a share values the company at £2.5bn.
And our two recommended articles for today…
Why you’ll regret it if you don’t buy gold
– Workers in the City are among the highest-paid in the world – so why do analysts get their predictions so wrong so frequently? Their performance has been worst when it comes to the gold price, says MoneyWeek editor Merryn Somerset Webb. Mainstream opinion only turned positive on gold as it soared up through $700 an ounce – and it then promptly plunged. But the gold story is far from over. To find out why you should be thinking about getting back in, see: Why you’ll regret it if you don’t buy gold
How to prepare for a new US depression
– A new depression in the US is practically inevitable, says Doug Casey in the Daily Reckoning. You can take your pick from the likely causes: the probability that we’re going to hit Peak Oil in the near future, escalation of the War on Terror, the massive US trade deficit – or all three. So what are the signs to watch out for – and how can investors protect themselves, or even profit from the coming storm? To find out, click here: How to prepare for a new US depression