Business Features
Analysis: Global economic tensions build on post-holiday blues
By DPA
Aug 28, 2006, 11:28 GMT

Berlin - In Germany, it is called the 'Sommerloch,' literally 'summer hole.' The French have a similar expression. In London it is the silly season. The Italians, however, say it like it really is: the traditional European summer slowdown in news is known in Italy as 'beach umbrella news.'

Whatever the expression, news out of the European financial markets has been less than exciting in recent weeks as analysts have joined economists, bankers and dealers in heading off for the annual summer holidays.

But the lazy, hazy days of summer could be coming to end as markets enter what is often the crazy days of September and the build-up to the end of the year.

It has become something of a ritual. As the warm weather takes over, the atmosphere on European markets starts to become a little more languid as the big financial centres empty out and the lunch breaks get longer for those left behind to run the dealing rooms.

However, as the past decade or more has shown, when they return from the beaches recharged and ready for action, market operatives have often delivered some hefty blows to key markets or currencies.

This year seems to be no exception with the vacation period coming to an end as a shift emerges in global business and economic sentiment on the back of concerns that the world economy could face a slowdown as it prepares to enter the new year.

'We are at a turning point,' said Kenneth Wattret, senior global strategist with BNP Paribas, who sees risks of increased market volatility in the coming weeks as economic perceptions start to change.

But then, the end of the holiday period can be a nerve-wracking time for investors. It was not that long ago that a changing market sentiment took hold, leading to a big sell-off in the common currency, which eventually pushed it down to a record low of 82.30 US cents.

It was also at end of the vacation time that the Russian rouble went into free-fall as a crisis over Moscow's foreign debt pushed the nation's economy to the brink of collapse and when the financial typhoon swept through Asia in 1997.

Only a few years earlier, traders returned to their desks after the summer break to rip the European Monetary System apart in a frenzy of selling that forced sterling into a humiliating retreat from the EMS, a move which deepened British scepticism about Europe.

But the pointers to what might unfold in the weeks following the holiday period often become clear long before the summer exodus takes hold.

Up until recently, the world economy has been remarkably adept in adjusting to oil prices trading at over 70 dollars a barrel.

But in the run-up to the holiday season this year European equity markets came under pressure as concerns set in about global economic growth as surging oil prices forced central banks to hike interest rates.

However, analysts say that the key to what happens in the markets this year once the summer holidays are out of the way is likely to be perceptions about the outlook for the United States' economy.

They say that in recent months a struggle appears to have emerged between those who believe that concerns about inflation should predominate and those who believe that the US economy is heading for a hard landing.

But despite some choppy trading, a batch of less-than-sparkling data out of the US and warning signals emerging from forward-looking European indicators, analysts say that the risks of slowing world economy have not yet been priced into many markets.

Moreover, they believe it may just take a major economic jolt from the world's biggest economy such as a dramatic rise in loan defaults or an oil supply shock because of geopolitical tensions to suddenly rock equity markets and lead to a shakeout in world stock prices.

This could especially be the case if high oil prices keep underpinning inflationary pressures and central banks, notably the European Central Bank, stick to their hawkish mantra threatening higher rates to counter inflationary risks.

Eurozone inflation data to be released later this week is forecast to show consumer prices in the currency bloc overshooting the ECB's 2-per-cent target again in August.

This will mean that inflation in the eurozone has been above the ECB's target of close to, but less than, 2 per cent every month since January 2005.

The euro has already started to gain ground against the yen on expectations that the ECB will continue to press ahead with rate hikes while the Bank of Japan will keep borrowing costs on hold after data showing weak core inflation.

At the same time, the US Federal Reserve appeared to have placed interest rates on hold after 17 consecutive increases.

Consequently, as northern hemisphere's summer slowdown comes to an end and trading rooms begin to bustle again, the markets may find that they are dealing with a euro heading back up to record territory just as the slowing world economy was starting to grind down European growth.

This is likely to follow growing pessimism about America's economic prospects, leading to a slump in the greenback against the euro.