Investor: An insider's guide to the market July has turned out to be a very strong month for equity markets and quite an eventful month for corporate and financial news. On the currency markets the big news was the announcement by the Chinese authorities that they were dropping the long-standing peg to the US currency.
On the announcement China engineered a small revaluation of the renminbi (Rmb) versus the dollar and announced that the currency would be fixed against a basket of currencies henceforth. This move by the Chinese was accompanied by a strengthening of most Asian currencies.
The move was generally welcomed in financial markets although it had little immediate impact. The renminbi is now trading at Rmb8.1 to €1, which is only marginally stronger than the old pegged rate. Therefore, it will do little in the short term to improve global trade imbalances. In the longer term it should be beneficial as it enhances the prospects for Asian currencies to adjust to trends in world trade.
This long anticipated change in the renminbi peg had virtually no impact on the euro/dollar exchange rate. So far this year the euro has declined from $1.34 to the current level of just above $1.20. On a trade-weighted basis the euro has now declined by 9 per cent year-to-date. There are signs, however, that this recent weak run by the euro may be bottoming out. It has bounced off the $1.20 level a number of times against a background of an improvement in the picture painted by recent economic data across the euro-zone economy.
The decline in the trade-weighted value of the euro this year is sufficiently large to have a material impact on the competitiveness of euro-zone industry. The year-to-date performance of European equity markets indicates that the European corporate sector is performing quite well. Of the major global equity indices, the FTSE Eurofirst 300 has excelled with a year-to-date gain of 13 per cent compared with the 3 per cent rise in the S&P500 index in the US.
This recent improved tone regarding the euro-zone economy and financial markets has removed any further talk of a possible cut in the ECB's 2 per cent repo rate. While economic conditions are not sufficiently strong to justify a rise in euro rates, the fact that a cut in euro interest rates is now only a remote possibility should lend some support to the currency.
Although US short-term interest rates are set to rise further, it is now widely expected that the Bank of England will soon reduce UK interest rates, starting with a quarter-point cut in August.
The UK's repo rate currently stands at 4.75 per cent so that a cut to 4.5 per cent would still leave sterling with relatively high interest rates.
However, further reductions would probably follow in due course so that the currency markets would quickly start to price in a much smaller interest rate differential in favour of sterling.
On balance, the moves seen so far this year in currency markets have been orderly and consistent with economic trends. The fall in the euro is giving a much-needed boost to the euro-zone economy. The resurgence of the US dollar has been accompanied by ongoing strong economic growth. The large US trade deficit is an issue that continues to cause concern among analysts and policymakers, but at least it doesn't seem to be worsening.
Finally the move by the Chinese authorities to dispense with the Rmb/US dollar peg could have very favourable long-term implications.
This benign international environment provides a very favourable backdrop to the Irish economy and stock market. Recently released economic data showed that the Irish economy was the fastest growing in the euro area in the first quarter of 2005. GNP growth was 3.9 per cent year-on-year, with the next best performances coming from Greece (3.9 per cent) and Spain (3.3 per cent).
Ireland's growth rate was slower than in prior quarters but is expected to pick up later.
Elsewhere in the EU it is only some of the new accession countries that are growing faster than Ireland. Estonia was the star performer, expanding by about 7 per cent year-on-year in the first quarter, followed by Lithuania and Slovakia.
This relatively stable international economic background combined with above-average Irish economic performance augurs well for the Irish equity market for the remainder of 2005.
