LONDON, 10 November 2003 — Last week, the long awaited decision on interest rates by the Bank of England (BoE) has set a new direction. After a recessive period lasting approximately three years, the BoE is the first major central bank to raise rates as the global economic recovery gathers pace. The rates were raised by 25bp, which is in line with most polled economists (35 out of 41). Why is the central bank entertaining an increase in rates in spite of inflation being relatively low and the British economy still growing below its potential?

The answer is that Britain experiences a steady continuation of record personal borrowing, massive house price increases, and exceptionally strong retail sales figures. Presently, these will be the determining factors in the outcome of the central bankers’ meeting. However, rises in interest rates will unlikely lead to a concerted effort of monetary policy tightening. For the European Central Bank, a rate cut is more likely than a hike in the sluggish euro zone anyways. The picture in the US is similar. In spite of astounding US economic growth exceeding an annualized rate of 7 percent in the third quarter, the Fed vowed to hold interest rates at 1 percent for a “considerable period”.

Last Tuesday’s report on US economic growth revealed an astonishing 7.2 percent real annual economic growth rate from July through September. Besides surges in consumer spending, we witnessed an impressive recovery of business investment. As this is an area people had been particularly worried about this is an encouraging signal and implies that the economy might have indeed turned the corner. On the other hand, consumer optimism is stimulated by the fact that the widespread fear of a jobless recovery might not fully materialize. The four-week moving average (most meaningful parameter as the weekly numbers are highly volatile) of initial jobless claims is trending toward 400,000. Companies are retaining workers as the economic recovery intensifies. In spite of the favorable developments, the Fed policy makers voted unanimously to maintain the overnight lending rate at the 45-year low of 1 percent. Based on the primary concern of inflation becoming undesirably low, the committee decided to maintain its economically accommodative stance. Although hitting new highs at the beginning of last week, stocks have remained largely flat over the last several days. Market participants are not yet convinced that the good US economic news is sustainable. Furthermore, concerns over the rapid advancement of markets over the last several months also weigh on higher moves. Today’s positive initial jobless claims report however, is likely to serve as a catalyst for the markets. From a technical point the cyclical bull market is still alive. From a technical view there are several reasons to be optimistic for equity markets.

Having a look at the Elliot-Wave-theory for the S&P 500, the fifth wave is still intact, but an important resistance line is likely to stop the advance. The price zone (1075-1100) includes the major 78.6 percent Fibonacci — Retracement confirming a serious barrier. Once this price zone is broken, we could even go to 1150 by the end of the year, which we think likely to happen. The mid-term uptrend is still intact, momentum is rising, and the overbought situation has been cleared. We therefore have some good signs indicating that we could reach that level, although the path will be characterized by up and down moves.

Our perception form the last technical outlook, expecting a bond market tending sideways, has mostly been fulfilled. Recent small price declines were due to a slightly over bought situation. However, the 10-year Treasury yields stayed in a fixed trend channel. We don’t expect significant breakouts in either direction but rather a market tending sideways in the short-term. Mid-term, however, we are clearly negative on bonds.

(Habib F. Faris is vice president at Clariden Bank, London.)