David Morris

EUROZONE investors had cause to cheer last week as bond auctions in Portugal, Spain and Italy went better than expected. As the auctions approached, their success looked pretty much guaranteed thanks to the efforts of the European Central Bank (ECB), along with promises of support from China and even chronically-indebted Japan. There was a sharp rally in the euro as traders rushed to cover short positions.

The single currency got a further boost during Thursday’s ECB press conference when Jean-Claude Trichet expressed concern at the recent up-tick in inflation. The Eurozone now joins China and the UK with inflation rates above preferred targets. On top of this, Friday saw US consumer price index (CPI) spike up 0.5 per cent in December, from 0.1 per cent the previous month. Also on Friday, the People’s Bank of China raised its banks’ required reserve ratio by 0.5 per cent, following six increases in 2010, and two outright interest rate hikes. Yet despite this, China is considered to be well behind the curve. If so, then we should expect the People’s Bank of China to tighten more aggressively this year. The Shanghai Composite fell over 3 per cent in response and this should serve as a red flag to equity investors elsewhere.

This has rapidly become the biggest issue for markets as food, fuel and other commodity prices continue to rise. In a worrying replay of 2008, soaring food costs are triggering social unrest around the world. In the UK, today’s CPI and retail price index (RPI) will be watched closely to see how price rises are feeding through to consumers, while this Thursday sees the release of the latest Chinese data for GDP, producer price index (PPI) and CPI.

The US housing market shows every sign of double-dipping, and it isn’t being helped by the foreclosure scandal which just won’t go away. This is a huge worry. While the Federal Reserve is busy congratulating itself on goosing equities via its second instalment of quantitative easing (QE2), it knows very well that the majority of Americans have the bulk of their asset exposure in housing, not stocks. As bond yields have yet to reverse after shooting higher post QE2, the latest Fed stimulus has done little to help the vast majority of US citizens. Whether it cares about this or not is another matter. We’ll get an update on the US housing market this week through indicators such as housing starts, building permits and existing home sales through Wednesday and Thursday.