Discussions on interest rate policy have been to the fore this week as the central banks continue their balancing act between providing a stimulus for economic growth and maintaining a steadying hand on inflation.

In Europe’s largest economy, Germany, economic growth has surprisingly accelerated at its fastest rate in 12 years. Gross domestic product in the first quarter of 2008 rose 1.5% from the fourth quarter of 2007 when it rose 0.3%. Spending on machinery and construction has been cited as the main reason for the strong performance with consumer spending and exports also contributing to economic growth.

Such strong performance in Germany, which accounts for about a third of the 15-nation euro-region economies, has prompted some analysts to suggest that the European Central Bank (ECB) may have room to leave interest rates at a six-year high as it fights inflation.

On the other hand, rising oil and commodity prices contributed to a rise in consumer prices of 2.6% in April from a year earlier, and a survey of economists by Bloomberg has indicated that the ECB may start cutting interest rates in September to bolster the euro-region economy.

Following a cut in the UK base interest rate, the Bank of England has presented its latest quarterly inflation report, which has quelled some expectations of a further cut next month. UK inflation has reached its highest level in 13 months at 3% on the back of high food and fuel costs. The Bank continues to face the challenges of a slowing economy and accelerating inflation.

Turning to oil, having hit a trading high of nearly USD127, a barrel of crude has been trading around the USD125 mark. The price fell at the start of this week on the back of reports that supplies in the US, the world’s largest consumer, probably increased for a fourth week as a result of falling demand.

There has also been comment that demand in Asia may reduce if Indonesia and Malaysia implement reductions in fuel subsidies as the cost of maintaining them has risen with the price of oil having climbed to a record. In addition, China’s strongest earthquake in 58 years may cut the nation’s ability to produce energy as a result of damaged power plants and transmission lines. China’s oil imports had already fallen for the first time in 18 months in April on the back of record crude prices.

Looking at currencies, the euro has risen against the dollar to stand at USD1.5516 following the news that economic growth in Germany was higher than forecast with its potential impact on interest rates. The euro also traded near a one-week high against the yen at Y162.93.

Meanwhile, on the equity front there are differing views on the continuing impact of the fallout from the credit crunch.

One view is that stock valuations have fallen to such an extent that the worst possible outcome is already priced in, although there has been the observation that this may be more applicable to emerging markets, which may be less exposed to the sub-prime situation.

While the initial impact of the credit crisis may have run its course in the developed markets, there is comment that the knock-on effects may continue for some time with, for example, high street customers having to contend with rising costs for basic consumer items and more onerous terms for home loans.

Whichever view on the outlook for financial markets is correct, make sure you speak to your Account Executive to find out how you can use Hansard’s range of innovative protected fund links when structuring and reviewing client portfolios.

David Findlay

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