The US Could Face Prolonged Economic Downturn

The U.S. could face a prolonged economic downturn due to its subprime mortgage woes, but is unlikely to plunge into a recession, Nobel economics laureate Joseph Stiglitz said Thursday.

Rising defaults on U.S. subprime mortgages have increased risks to the economy, with a worsening housing slump, credit problems and turbulence in global financial markets, said Stiglitz, a former World Bank chief economist who is here to attend a conference. Some 1.7 million Americans may lose their homes due to foreclosures and bankruptcy this year, piling further pressure on house prices, he said. Wages have stagnated although the U.S. gross domestic product was some 20% higher now from six years ago, he said. "Mortgage payments are going up, house prices coming down, incomes are stagnating. It's not a pretty picture. So the dynamics could unravel more and where it stops, we can't be sure," Stiglitz told reporters on the sidelines of the conference. "We don't know how well the (U.S. Federal Reserve) will respond. The lack of transparency means we don't know how deep the problem is," he said. "The most likely outcome is that it will be a rather prolonged slowdown but not a recession." Stiglitz said the credit crunch was a "totally predictable disaster" due to U.S. President George W. Bush's economic policies in 2001 when Bush cut taxes for the rich, slashed interest rates and encouraged people to borrow more than they could afford to stimulate the economy. The U.S. is living beyond its means, borrowing some $850 billion last year, while household savings in the country is nil or negative, he said. "President Bush has mismanaged the economy very badly. The magnitude of total government borrowings in the eight years of his presidency will be over $4 trillion," Stiglitz said. "President Bush has put America in an impossible place." Bush's terms ends in January 2009. Stiglitz, who won the Nobel Prize for economics in 2001 and is author of "Globalization and its Discontents," warned the next U.S. administration faces a tall task in restoring fiscal sanity as this involves cutting back on expenditures or raising taxes - which could lead to bigger budget deficits. "The timing has to be done very carefully ... if it is not carefully managed, the fiscal consolidation will further depress the economy," he said. Stiglitz indicated that East Asian countries may not be severely hit by the U.S. fallout, as the region has built large reserves and are much more resilient after rebounding from its own financial crisis a decade ago.

Credit Woes Boost Hong Kong, Drag On Taiwan

Hong Kong, seen by some as a haven in Asia during times of financial volatility, came out as a favorite among international fund managers in August as U.S. subprime woes roiled financial markets, according to Dow Jones Newswires' monthly poll of fund managers active in Asia.

Hong Kong has long been seen as a safer way to invest in China's growth. Not only have valuations in Hong Kong been lower, but as a more developed market than those in Shanghai and Shenzhen, Hong Kong's stock market is more liquid. Although this liquidity can be a recipe for volatility, it also appeals to fund managers who don't want to be parked in a market with no way out. As Chinese regulators loosen up restrictions, allowing more mainland Chinese investors invest in Hong Kong stocks, Hong Kong's stock market is poised to see even more interest. Hong Kong's status as a safe haven could now "with its fast growing financial ties to China...become even more pronounced," said Nicholas Brooks of Henderson Global Investors. The loosened rules came as the Chinese yuan is appreciating against the Hong Kong dollar, helping make Hong Kong assets more attractive to mainland investors. Back in January, the yuan moved up to parity with the Hong Kong dollar for the first time in a decade. One yuan is now worth 1.03 Hong Kong dollars. Fund managers, on average, moved Hong Kong to a solid overweight in August, its highest weighting in months, up from slightly overweight. A dip in Hong Kong's Hang Seng index earlier in the month helped make for some better values, fund managers said. If changing credit conditions helped boost Hong Kong's appeal, the same issues weighed on the Taiwan market. Taiwanese stocks - a favorite last month - declined to a slight underweight in this month's poll. Taiwan's economy, which is tipped heavily towards technology and semiconductors in particular, is very much dependent on U.S. demand for its exports. Tightening credit markets increased fears about the U.S. economy falling into a recession, which would bode badly for Taiwan. The subprime concerns "seem more serious and we think it may cause a slow down in the U.S. housing market which may affect U.S. consumers and cause them to demand less products from Taiwan," said Grace Tam, investment services manager at JF Asset Management. J.P. Morgan Securities downgraded the Taiwan stock market to underweight within its regional equities portfolio on Monday. "Given that Taiwan is the emerging market with by far the highest exposure to the global consumer, the risk of earnings downgrade is increasing, notably in tech," a J.P. Morgan analyst wrote. While the island's tech sector stays under close watch, Taiwan materials and financial segments remain favorable, the firm said. In other parts of the region, Indonesia got a solid overweight weighting while China and India are slight overweight. Old favorites China and India have continued to stay on the radar, despite historically high valuations, because of long-term growth prospects. Indonesia, on the other hand, has been seeing increased interest because of relatively lower valuations. Indonesia was "the last market to recover post crisis," notes Prudential. Indonesian companies are now posting strong earnings, notes JF Asset Management's Tam, and though the country's central bank stopped cutting interest rates recently, it has room to do so again in the near future if inflation remains benign. An interest rate cut would benefit property and financial sectors.

Better Value Outside Asia

Asia-focused funds started seeing outflows in August as Asian markets rebounded on the Federal Reserve's discount rate cut, pushing the region's stock prices higher. According to Citigroup, redemptions from offshore Asian funds climbed to $2.6 billion last week. With prices in Asian markets continuing to climb, relatively cheaper European stocks have been more attractive. "Asian equity markets look poor value relative to equities in developed economies. While it is probably right to assume that output and profits growth will be faster in Asia over the medium-term, it is also true that volatility is likely to be higher too and that should be reflected in valuations," said Henderson's Brooks. Each month, Dow Jones Newswires surveys fund managers on portfolio weighting recommendations for the succeeding months, with most looking at a 12-month horizon. This latest survey was taken over the past 10 days. The respondents for this month's survey were Aberdeen Asset Management Asia, Credit Agricole Asset Management, Henderson, Halbis, ING Investment Management, JF Asset Management, Prudential Asset Management, Schroder Investment Management and Standard Life Investments. For the survey, each participant was asked to assign recommendations to each asset class. The weightings from each fund manager were then averaged: 0 is neutral, up to +0.5 is slightly overweight, above +0.5 to +1 is overweight, above +1 is very overweight. Meanwhile, 0 to -0.5 is slightly underweight, below -0.5 to -1 is underweight, below -1 is very underweight.

Market Turmoil Opens Door For Chinese M&A

China's major oil companies have been biding their time before embarking on a fresh round of takeover activity, but many experts feel the opportunities afforded by the current turmoil on global markets may be too good to ignore.

Valuations of oil and natural gas assets have fallen in step with stock markets, while a credit squeeze has put U.S. and European Union oil producers under pressure to conserve their balance sheets and freeze any acquisition plans for now. This has opened the door for the Chinese and rivals in India, which have amassed piles of cash during the oil price rally, are relatively debt-free, and need to buy oil reserves to grow. That said, political considerations may limit Chinese ambitions to bolt-on acquisitions of oil minors rather than transformational deals with the majors. PetroChina Co. (PTR), for example, had $9.5 billion dollars in cash on its balance sheet at the end of June, and would have access to finance from China's state banks, which have been largely unaffected by the troubles of their counterparts across the Pacific. China's largest-listed oil producer by capacity aims to replace all the crude that it produces over the next two to three years with new reserves. "Tightening of credit conditions for U.S. and E.U. companies may trim global valuations for hydrocarbon assets, which would be ideal for big spenders like PetroChina," said Bradley Way, a Beijing-based analyst at BNP Paribas. Stock markets around the world have been shaky since defaults in U.S. subprime mortgages triggered huge losses in the financial sector and dulled investor appetite for risk and new debt. Between July 19 and August 16, the Dow Jones Industrial Average in the U.S. fell 8.2%, and has only recovered a portion of those losses since then. Most indexes across Asia mirrored its decline. On Wednesday, Asian markets fell sharply again after the DJIA lost 2.1% overnight on evidence that credit woes have fed through into the wider U.S. economy. According to Prashant Gokhale, an analyst at Credit Suisse, the initial impact of the credit squeeze is already being felt in the oil sector through companies facing a higher cost of capital. A prolonged bout of market turmoil could lead to slower economic growth globally, trimming oil demand and hurting refiners and petrochemicals producers especially, he said. "If the current contagion continues it could throw up interesting mergers and acquisitions opportunities for companies with strong balance sheets," Gokhale said. "Extended market turmoil could help by bringing asset valuations down to levels where they become more realistic," he said. Cnooc Ltd. (CEO) is likely to be a key beneficiary of acquisition opportunities thrown up by prolonged market turbulence, along with its drilling unit China Oilfield Services Ltd. (2883.HK), which harbors ambitions of expanding further aboard, he said.

Constraints Remain On M&A Ambition

When painted against China's need to offset stagnant domestic oil production with foreign oil, the acquisition schedule of PetroChina and domestic rivals Cnooc and China Petroleum & Chemical Corp. (SNP), known as Sinopec, seems oddly slow. Since the multibillion dollar takeover of the Udmurtneft unit of Anglo-Russian oil producer TNK-BP Holdings (TNBP.RS) by Sinopec in June last year, China's state oil trio have remained mostly on the sidelines as the wider oil sector has consolidated. Chinese companies accounted for just 5% of the $565.9 billion worth of deals involving energy firms globally last year, according to analysis firm Dealogic. Indeed, the total value of all deals involving Chinese energy companies last year - $27.3 billion - was just above the $23.3 billion double acquisition unveiled by U.S. oil producer Anadarko Petroleum Corp. (APC) last summer. Even if China's oil executives decide that now is the time to accelerate their acquisition schedule, analysts say they will be confronted by familiar problems, notably the reluctance of Western governments to allow the Chinese a tighter grip on global oil resources. The U.S. remains off the map for Chinese companies due to worries about the political opposition that would be stirred up in Washington should a takeover bid for a large-cap U.S. company be launched. The U.S. has just tightened laws on foreign investments, making them subject to greater scrutiny than before. Even comparatively benign governments appear to be taking steps to protect domestic firms against Chinese takeovers. Canada is looking again at its foreign investments policy, which may lead to the introduction of a national security review clause. Without the support of Western governments, China's oil companies have little freedom to make big acquisitions. This is a particular problem for PetroChina, which is vying with Royal Dutch Shell Plc (RDSA) and BP Plc (BP) for the rank of second-largest oil company in the world behind ExxonMobil Corp. (XOM). "PetroChina is an M&A candidate, but finding a target is difficult given its size," said Credit Suisse's Gokhale. China's companies may have to content themselves with mopping up smaller companies or individual assets as they become available, continuing a strategy in place since Cnooc's aborted $18.5 billion takeover campaign for California-based Unocal Corp. in 2005. Reports in Hong Kong media say PetroChina's parent China National Petroleum Corp. has bid $2 billion for the West African oil and gas assets of U.S.-based Devon Energy (DVN). People familiar with the situation have told Dow Jones Newswires that Cnooc and Zhenhua Oil are considering bidding for Transmeridian Exploration Inc. (TMY), which owns an oil field in Kazakhstan. In addition to political opposition, oil prices have stayed high and this is likely to prevent asset valuations from falling too far. Steven Knell, an energy analyst at consultancy Global Insight, notes that, while China's oil executives may be licking their lips at the prospect of falling asset prices, it's the country's own hunger for raw materials that may end up preventing a sharp decline. Another factor possibly discouraging Chinese companies from jumping now to take advantage of falling valuations is this autumn's Communist Party Congress in China, which is held every five years and determines the major promotions and demotions within the government's ranks. The chief executives of China's state oil trio are unlikely to risk damaging their political careers by launching an audacious acquisition move prior to the Congress, scheduled to convene on October 15. "The Chinese companies may be waiting until after October so they can get a political sanction to make an acquisition," Knell said.

Widespread Selling A Stock Picking Opportunity

For all the lipservice paid to decoupling, stock traders in Asia certainly don't seem to be willing to put their money behind the concept.

Stock markets in Asia fell across the board Wednesday, in a selloff sparked by worry that a housing slump and credit crisis in the U.S. will pull that economy into a slowdown, or even recession. Few stocks in Asia held up well to the pressure - not even those that are likely to avoid being dragged into the mess. "The steady stream of bad news has already prompted investors to stop giving the benefit of the doubt," analysts at Standard Chartered wrote to clients on Wednesday. Still, indiscriminate selling creates buying opportunities and that means stock pickers are likely busy these days scrubbing their markets to find companies that are least likely to be impacted by a slowdown in the U.S. There are two groups worth exploring: those housed in economies that aren't exposed to the U.S., and the infrastructure giants whose work comes with long-term contracts that aren't exposed to the factors that will weigh on the U.S. economy. The big picture is a starting point. ABN Amro recently ranked Asian countries by their exposure to a U.S. slowdown, categorizing Thailand and Taiwan as having the highest risk - thanks to their dependence on exports for gross domestic product growth - and India and Indonesia as having "relatively low vulnerability." Indeed, "Indonesia's reliance on exports to the U.S. is one of the lowest in Asia, with economic growth mainly driven by domestic factors," Citi Investment Research analyst Stephan Hasjim recently wrote in a note. Hasjim covers Indonesian banks, and thinks that they remain attractive targets because investment and higher fiscal spending in Indonesia, loan growth and relatively low interest rates will all offset the impact of a U.S. economic slowdown. For example, the Indonesian government said earlier this month it plans to increase its capital spending by nearly $11 billion, a nearly 50% increase, to pay for infrastructure projects - everything from highways to electricity and irrigation infrastructure. Narrowing in on banks that are most likely to grow earnings as they do their loan portfolios, and are also sheltered from falling yields on bonds and assets, two stand out: Bank Rakyat Indonesia (BBRI.JK) and Bank Danamon Indonesia (BDMN.JK). Bank Rakyat fell 3.3% to IDR5,900 on Wednesday, and has lost 6% so far in August. Bank Danamon dropped 4.5% to IDR7,350 on Wednesday and is down about 10% so far in August. But for those unwilling to count on the fact that companies in Indonesia or any other relatively insulated economy will survive all the spillovers sure to come their way, a second transnational group of stocks might offer a compelling opportunity. These are the giants that build the national infrastructure like airports, power plants and roads that countries like Indonesia are pouring billions of dollars worth of investments into. "Infrastructure is a mega-trend," said Roger Groebli, head of Asian equity research at ABN Amro Private Banking, and there are companies cashing in on it. Groebli points to companies that have a finger in many pies. Japan's Marubeni Corp. (8002.TO) is one, for example, that is developing power plants and other infrastructure around the world from power plants in Indonesia to water desalination in the United Arab Emirates. Marubeni fell 1.3% to Y899 Wednesday, and has lost 22% so far this month. Another is Toshiba Corp. (6502.TO), which is driving an increasing percentage of its revenue from stable and long-term infrastructure projects like building nuclear power plants, rather than its fairly commoditized memory chip business. Toshiba was off 3.4% Wednesday to Y1,010, and has lost about 10% so far this month.

Euro Likely To Suffer One Way Or Another

The euro zone may well prove immune to the subprime mortgage woes sweeping through the U.S. economy. But that doesn't mean that, as a high-yielder, the euro won't still suffer from rising global risk aversion.

Much, of course, will depend on whether the European Central Bank feels it can afford to hike interest rates again next week. Increasingly, though, it looks like fears of a credit crunch will be the deciding factor. "Financial market conditions rather than the macro data will determine the fate of the ECB's rate decision next week," said Martin van Vliet, senior euro-zone economist at ING Financial Markets in Amsterdam. ECB President Jean-Claude Trichet hinted as much when he took an important step back from the bank's previous hawkish stance earlier this week, admitting to reporters after a speech in Budapest Monday that the bank is not "precommitted" to higher rates at its next meeting Sept. 6. Only last week, the ECB was declaring that its underlying policy remained unchanged despite the recent need to add liquidity to European markets, as a rise in risk aversion brought a sharp deterioration in global credit conditions. Trichet's apparent shift in position has coincided with data suggesting that while the U.S. economy is looking increasingly vulnerable to subprime problems, the euro zone isn't. Take the Ifo survey of German business sentiment that was released Tuesday - instead of falling back to 105.2 as expected in August, the main sentiment index only fell to 105.8 from 106.4 in July.

Euro's Weakness Widely Expected

Given the recent rise in euro-zone interest rates, the strength of the euro and the weakness in U.S. growth, the deterioration in sentiment had been widely expected. What was surprising, however, was that the volatile conditions of global financial markets in recent weeks didn't have more impact. If anything, sentiment could improve from here. "Comments from the Ifo Institute suggested that the dip in expectations was normal and that with overall growth still robust economic sentiment could improve next month," noted Stuart Bennett, a currency strategist at Calyon Credit Agricole in London. The Ifo has "defied market turmoil," said Erik Sonntag, ING's German economist in Brussels. "An impact on the real economy cannot be detected so far." For the ECB, new money supply data only added to the impression that inflation remains a risk for the euro zone. The three-month average measure of the region's M3 money supply surged to a two-year high of 11.1% in July from 10.6% in June. The market had expected growth to accelerate to only 10.9% on the year. "With money and credit growth remaining in double digits, the ECB will stay seriously concerned about the medium to long-term inflation outlook for the euro zone," ING's van Vliet admitted. Nevertheless, many analysts remain convinced that the ECB will take its cue from global trading conditions that a credit crunch may yet develop, even though there is little sign of fallout in the euro zone economy just yet. "Given Trichet's comments effectively flagging that the bank is in a 'wait and see' mode and will delay the previously expected rate hike on Sept. 6, the data are unlikely to have an impact on policy," said Calyon's Bennett, as he noted the fears a financial crisis could imply fewer funds being made available to firms in the months ahead. Stephen Jen, senior currency strategist with Morgan Stanley in London, suggested that Trichet's comments are consistent with the view that there is a slightly better than 50/50 chance of a rate hike next month. Also, he added, it probably means the end of the ECB's recent policy of giving heavy forward guidance to the market of its rate views as the outlook for the global economy turns more uncertain.

UN Climate Talks Seek Greater Commitments To Cut Emissions

Climate experts from more than 100 countries opened a weeklong U.N. conference Monday, seeking tougher commitments to cut greenhouse gas emissions and turn the tide on global warming.

Yvo de Boer, the U.N.'s top climate official, pointed to the European Union's recent goal of reducing emissions by 20% by 2020 - and by another 10% if other nations join in - as an example of what can be done. "That's exactly the kind of thing that developing countries are looking for from rich countries," he said. More than 1,000 delegates were gathering in the Austrian capital for talks aimed at advising nations, corporations, bankers and public institutions, such as the International Monetary Fund, how to make the most of their energy investments. A new report by the U.N. Framework Convention on Climate Change says additional investments of about $210 billion a year will be needed - mostly in the developing world - to maintain greenhouse gas emissions at their current levels in 2030. Experts are working to ensure the $20 trillion the world is projected to spend on energy over the next two decades is as environmentally friendly as possible. The Vienna meeting, which runs through Friday, is part of a flurry of talks leading up to a major international climate summit in Bali, Indonesia, in December. De Boer said there would be no "spectacular decisions" made this week. But he said delegates would try to forge a practical way forward ahead of two other key pre-Bali sessions: a Sept. 24 meeting at U.N. headquarters in New York, and a meeting three days later in Washington of the world's 15 biggest polluters, including the U.S., China and India. De Boer praised Bush for arranging that meeting and for indicating he wants the U.N. to supervise the overall climate control agenda. But he also took a good-natured jab at Washington, which has refused to ratify the 1997 Kyoto Protocol. Among other things, the landmark treaty requires 35 industrial nations to cut their global-warming emissions 5% below 1990 levels by 2012. "I guess you could say President Bush has taken the bull by the horns. The question now is where will Bush and the bull go," de Boer said, provoking laughter. China also has come under scrutiny at the Vienna meeting. Beijing has committed itself to cutting energy consumption by 20% a unit of gross domestic product, along with a 10% cut in major pollutants, between 2006 and 2010. But it failed to hit its initial targets last year, and by some accounts already has overtaken the U.S. as the world's biggest polluter. De Boer, however, said China and other developing nations such as India, Mexico and South Africa deserve credit for setting ambitious goals to slash the amount of ozone-eating gases they emit. "There's this myth out there that developing countries are doing nothing," he said. "It's not true." Experts working to craft a road map for slowing or even reversing climate change after Kyoto expires are struggling to strike a balance between what rich and poor countries can do. One key option, de Boer said, might be to broaden the "menu of choices" now available to countries, such as financing "clean and green" hydroelectric or wind power.

Asian Stocks, Currencies Fall As US Economic Concerns Mount

Asian stocks are lower early afternoon Wednesday as investors turn their attention to the health of the U.S. economy - and the implications of any U.S. slowdown for a region which still relies heavily on exports.

Regional currencies are also weaker while the yen has found some safe-haven interest along with domestic government bonds.

The moves come on the heels of a drop in U.S. stocks as concern mounts about the spillover to the broader economy of a housing price slump.

While some stock markets have come off their initial troughs, the falls are a reminder that major concerns about the U.S. housing sector and credit markets are yet to be resolved, and that more volatility is likely as investors seek clarity on the economic front.

U.S. stock futures are largely flat in screen trade but spreadbetting companies are calling European markets to follow Asia lower, with Cantor Index forecasting the U.K.'s FTSE 100 index down 45 points and Germany's DAX 30 down 77 points.

Standard Chartered in a research report warned "the macroeconomic impact from the subprime fallout is real."

It expects investors to continue to exercise caution, "with recoveries being seen as opportunities to exit positions rather than as a reason to believe there is no more bad news to come."

Maki Shimizu, a Japanese Government Bond strategist at UBS in Tokyo, said, "the markets are concerned about the impact on the real economy going forward, which will be more serious than the market originally thought, or at least it's coming sooner than the market expected. This kind of market turmoil really shows the global connections."

A report out earlier in the week by UBS noted Singapore and Hong Kong appear most exposed to any global economic slowdown, with India and China on the low side and South Korea and Taiwan bunched in the middle. It also said Taiwan and South Korea's economies are the most leveraged in Asia, ex-Japan, and a drop in export-derived income could thus have a relatively larger impact on consumption and investment in those economies.

In some stock markets, Wednesday's selling erased what was left of gains logged over the past week. Japan's Nikkei 225 index dropped 2.5% to 15878, Korea's Kospi Composite fell 1.4% to 1,803, and Australia's S&P/ASX 200 declined 1.8% to 6066. Taiwan's Weighted Index fell 1.8% to 8566.15.

The selling was broad based, and in Japan a rising yen continued to pressure shares of exporters.

The yen was recently at Y114.06 to the dollar, after falling as low as Y113.86. The euro broke below Y155 to touch Y154.62, while the New Zealand dollar was at US$0.6916 after a brief foray under US$0.6900.

The flight to safer investments led investors to government bonds. In Japan, lead September Japan Government Bond futures were up 0.46 at 135.90 after touching 136, their highest level since August 22.

Asia's credit default swaps were also showing wider spreads with the iTraxx Asia ex-Japan index quoted at 92-98 basis points after closing at 86.70 basis points Tuesday. Philippine 5-year CDS - a benchmark for Asia's high-yield bonds - were quoted at 195 basis points compared with 177 basis points Tuesday.

More U.S. August Economic Data Awaited

Analysts pointed to growing concern about the effect on the U.S. - and global - economy of a prolonged slump in the U.S. housing market, which may now be feeding into consumer sentiment.

Overnight, the S&P/Case-Shiller home-price index was reported 3.2% lower in the last quarter, from the same period a year ago. Also, the Conference Board's reading of consumer confidence dropped sharply in August, to 105 from 112.6 in July - though this result was largely in line with market forecasts.

Traders expect a series of Federal Reserve interest rate cuts in coming months, aimed at shoring up economic growth. The December fed-funds futures contract is currently pricing in a 88% chance for the interest rate to be at 4.25%, a full percentage point below its current level.

Up for discussion now is whether the Fed will act before its scheduled meeting in late September. "We've got a fresh bout of jitters now, but the Fed won't want to overreact, I think they will want to wait until September 18 before doing anything," said Khoon Goh, ANZ Bank senior economist in Auckland.

There's more U.S. economic data in store this week, while Fed chief Ben Bernanke will give a speech which may clarify how likely a rate cut is for September.

"The only possible positive incentive we can expect for the stock market this week is Bernanke's speech" on Friday, said a trader at a Japanese brokerage.

Tinkering Days Ending; Attention Back To Rates

Barring approval of chickens, goats and grandma's silver as collateral at the discount window, it seems the Federal Reserve is close to running out of non-interest-rate tools to boost liquidity in credit markets.

And amid signs of market stability, there is a growing sense that officials can wait until the Sept. 18 meeting of the Federal Open Market Committee to adjust interest rates, with expectations centering on quarter-point reductions in the federal funds and discount rates. "In terms of the minor changes, they've used up a lot," said Zach Pandl, an economist at Lehman Brothers. "It's conceivable there's something else out there," said Lou Crandall, economist at Wrightson ICAP. However, "I think we are getting to the point (when) anything they could do easily they would be doing right now," he said. Following its surprise 50-basis-point reduction in the discount rate to 5.75% on Aug. 17, the Fed last week clarified the types of collateral that could be used for short-term borrowing. On Friday, the Fed said banks could pledge asset-backed commercial paper for which it is the liquidity provider. "If this reduces the number of borrowers paying distress prices in the (asset-backed commercial paper) market, it would help alleviate one of the more visible signs of stress in the financial system at present," Crandall said in a research note.

Fed Needs To Do More...But More Of What?

The Fed last week also allowed exemptions for banks to lend more capital to brokerage affiliates and encouraged large banks to use the discount window. Several major banks did so last week. Those actions appeared to calm equity markets and parts of the credit markets. However, "at the end of the day, these actions will probably not be enough," said Tony Crescenzi, strategist at Miller Tabak, since "some of the credit previously extended by investors and banks will not be extended in the near future." Indeed, strong demand at Monday's Treasury auction of $43 billion in three- and six-month Treasury bills highlights that there's still much demand for the safest places to park cash. Other steps the Fed could take should conditions erode again include further expanding the types of collateral pledged at the discount window or by altering the "haircut" to determine the amount the Fed will lend on illiquid collateral. However, "if they're going to start splitting hairs between now and the (Sept. 18 FOMC) meeting, (saying) we'll decrease the haircut (on collateral), and they make all these steps shy of a rate cut, the market would get impatient and say 'come on already,'" said David Ader, chief bond strategist at RBS Greenwich Capital. "Recent stability is contingent upon further action from the Fed and can hence reverse if there is no further action from the Fed," said Miller Tabak's Crescenzi. He thinks the Fed will have to consider lowering the discount rate further towards the federal funds rate of 5.25% or cut the fed funds rate itself. "If there is no new money, the money that exists will stay parked in less-risky assets such as T-bills, providing too little relief," Crescenzi said.

Bernanke's Jackson Hole Speech Eyed

Increased calm in financial markets coupled with recent durable goods orders and jobless claims data - which suggested the economy had enough momentum to withstand the recent credit crisis - have forced investors to back away from expectations of an intermeeting rate reduction. Still, many banks see the Fed lowering the fed funds rate by 25 basis points to 5% next month. And Ader at RBS Greenwich said the Fed would probably combine such a move with a discount rate cut as well since officials want to encourage discount window use to facilitate financing. It would probably take a direct signal from the Fed to get investors to back off those expectations. When the Fed lowered the discount rate on Aug. 17, it issued a rare intermeeting policy statement saying downside economic growth risks had risen "appreciably," which many Fed watchers took to suggest officials now have an easing bias. Since then, the only major economic remarks have come from Richmond Fed President Jeffrey Lacker. Though he stressed that inflation remains a concern, Lacker's speech didn't seem to sway investors from rate-cut bets, perhaps since Lacker is known to be one of the more hawkish members of the Fed and thus such statements aren't surprising coming from him. Fed watchers will closely eye a speech Friday by Fed Chairman Ben Bernanke at the Kansas City Fed's annual symposium in Jackson Hole, Wyoming, for clues. Bernanke has been silent since Aug. 17, though following a meeting last week between Bernanke, Treasury Secretary Henry Paulson and Senate Banking Committee Chairman Christopher Dodd, D-Conn., Dodd said Bernanke promised to use "all the tools available" to respond to market volatility. The topic of Bernanke's speech, housing and monetary policy, seems ideally suited to send a message to markets. But the timing might not be right, since economic data released in the days after Bernanke's speech will provide much-needed information about how the economy performed in August. "It's a very interesting set-up," said Wrightson's Crandall, but "we're not looking for a direct policy signal."

Big Capital Flows Into Asia Need To Be Watched

Bank of Japan Deputy Gov. Toshiro Muto said Tuesday that big capital flows into Asia need to be watched carefully because they could cause problems such as rises in asset prices fueled by excess liquidity.

His remarks come as the U.S. subprime loan crisis causes turmoil in Asian markets as well, underlining the region's sensitivity to global market developments. "Responding to the abundant capital inflows in recent years hasn't been easy, and has caused Asian authorities to face various problems," Muto said in a speech about the Asian economy at a local conference. For example, many Asian nations have had to intervene to halt the local currency from strengthening, resulting in a sharp rise in foreign exchange reserves and an increase in local currency liquidity that needs to be sterilized by central banks, Muto said. That's hurt central banks' balance sheets, he said. Meanwhile, capital inflows have resulted in excess liquidity that's pushed up prices of assets such as real estate and shares, and that "could threaten price stability in the long term," the deputy BOJ governor said. To deal with huge capital flows Asia needs to develop a better regional bond market, but much work is still needed, Muto said. Asia's financial integration also lags that of other regions such as the European Union, he said. Muto said that authorities need to watch out for a resurgence in protectionism, including in the U.S., that comes as a result of Asia's economic development. He noted that some developed countries are also beginning to worry that so-called sovereign wealth funds, which use foreign exchange reserves as funds, could buy out important companies and financial institutions.

UN Climate Talks To Focus On Business End Of Global Warming

This week's latest round of talks on climate change, which get under way in Vienna Monday, will focus on ensuring the $20 trillion the world is projected to spend on energy over the next two decades is as environmentally friendly as possible.

This week's latest round of talks on climate change, which get under way in Vienna Monday, will focus on ensuring the $20 trillion the world is projected to spend on energy over the next two decades is as environmentally friendly as possible. "We need to 'climate-proof' economic growth," Yvo de Boer, the U.N.'s top climate official, told reporters Sunday. More than 1,000 delegates were gathering in the Austrian capital for talks aimed at advising nations, corporations, bankers and public institutions, such as the International Monetary Fund, how to make the most of their energy investments. A new report by the U.N. Framework Convention on Climate Change says additional investments of about $210 billion a year will be needed - mostly in the developing world - to maintain greenhouse gas emissions at their current levels in 2030. "If the funding available...remains at its current level and continues to rely mainly on voluntary contributions, it will not be sufficient," the report warns. Experts say developing countries will need billions more each year to help them adapt to changes in their climates. An example is the southern African nation of Lesotho. The impoverished country relies heavily on agriculture, yet it is being hit with twice as many droughts as it endured in the 1980s, Lesotho Environment Minister Monyane Moleleki said. Complicating matters: Since 2000, Januarys and Februarys have become progressively warmer. "When the rain does come, it comes in deluges - torrents - useless for our agriculture," he said, appealing to industrialized nations for technology and resources to help his country adapt and overcome what he called "a very dangerous situation." Maria Magdalena Brito-Neves, environment minister of Cape Verde, a chain of islands off western Africa's coast, said climate change has also produced chronic drought and threatened delicate ecosystems. "We are very vulnerable," she told journalists. The Vienna meeting, which runs through Friday, is part of a flurry of talks leading up to a major international climate summit in Bali, Indonesia, in December. De Boer said participants would "take the temperature" of global climate-control negotiations before two other key sessions that will precede the Bali conference - a Sept. 24 meeting at U.N. headquarters in New York, and a meeting three days later in Washington of the world's 15 biggest polluters, including the U.S., China and India. The U.N. is leading the push to discuss a successor agreement to the 1997 Kyoto Protocol, which expires in 2012. Among other things, the treaty requires 35 industrial nations to cut their global-warming emissions 5% below 1990 levels by 2012. The European Union has set a new goal of reducing greenhouse gases by 20% by 2020 and by another 10% if other nations join in. "It's critical to have all the partners on board," including the U.S., which hasn't ratified Kyoto, said Josef Proell, Austria's environment minister. "We need more than Sunday sermons. We need clear measures." De Boer's office details the challenges in its 216-page report. Among the hurdles: The world will remain heavily dependent on fossil fuels, meaning it must find new and affordable ways to burn coal and oil more cleanly and recapture carbon dioxide emissions. "The war against climate change is not a war against oil. It's a war against emissions," de Boer said.

Avoiding A Bernanke Put

Debt markets have in recent days been pricing out the chance of aggressive Federal Reserve monetary policy easing - and for investors in Asia that is good news.

Urgent rate cuts - either outside of regularly scheduled policy meetings or overly deep - are something the Fed should avoid if at all possible, in part given the potential for moral hazard from a Bernanke "put."

That doesn't mean the Fed will necessarily shy away from cutting interest rates 25 basis points from the current 5.25% at its next meeting, Sept. 18.

But it does mean any action from the central bank should be designed to avoid conveying a sense of panic to markets.

It also means Bernanke & Co. will avert creating the perception the Fed will rescue markets from themselves.

If investors believe the Fed will always step in to save the day, it could bring about a return to the extreme environment of recent years, when there was no apparent need to worry about risk. That excessive appetite for risk - in a climate of low rates and easy access to money - is the very thing which helped create the recent liquidity crisis.

For Asia, including Australia, a major repository of private equity deals in the past 18 months, one of the worst things that could happen would be that risk appetite becomes unfettered again.

This crisis has been about a repricing of risk to more balanced levels. If that repricing becomes short-lived, the potential for further - and more damaging - crises down the track will become a real concern.

This threat of moral hazard from big rate cuts will no doubt be a major part of the thinking at the Fed in coming weeks.

There will be much focus on Chairman Ben Bernanke's first public comments since the onset of the crisis, when he speaks Friday at the Kansas City Fed's annual symposium in Jackson Hole, Wyoming.

Expect Bernanke - and his colleagues - to talk carefully about the recent volatility, but he may also indicate the central bank is unlikely to move preemptively to cut rates before Sept. 18.

This is a great chance for the Fed to sound a combined note of calm for markets by not encouraging talk of hefty easing.

Such a strategy would be especially justified if cautious optimism continues in the coming week in markets. It would also be justified if data out this week show the U.S. economy remains on a solid footing despite the recent market wobbles.

Investors Feeling a Bit More Optimistic

Wall Street Returns to Work Feeling a Bit More Optimistic in Wake of Fed's Interest-Rate Cut.

Wall Street heads back to work this week in a somewhat calmer state of mind. Overall, investors are more optimistic now about the financial markets than they've been in several weeks.

An interest rate cut from the Federal Reserve is far from guaranteed, but after the central bank lowered its discount rate on Aug. 17 -- a rate that several major banks took advantage of -- Wall Street feels it can rely on the Fed as a safety net.

The market had its most stable week in a month last week. The Dow Jones industrials rose back above 13,300 after momentarily dipping below 12,600 in the prior week. The Dow finished up 2.29 percent for the week, the S&P rose 2.31 percent, and the Nasdaq added 2.86 percent.

Meanwhile, the yield on the three-month Treasury bill recovered to a more reasonable 4.23 percent, after briefly falling under 3 percent last Monday as nervous investors fled to the safety of short-term government securities.

Though some the worst is over for stocks, that the underlying strength in the economy and corporate America will help the market overcome any credit troubles, others argue things will get more difficult before they get better.

Worries about tightening credit haven't disappeared, with the housing market looking dismal and certain types of assets still hard to sell -- like asset-backed commercial paper, normally an easy way for companies to get cash.

It's possible that without a rate cut from the Fed, stocks could tumble further. Traders are betting on the Fed cutting the benchmark fed funds rate at its Sept. 18 meeting or sooner, but many economists say the central bank -- which has held rates steady for over a year -- is unlikely to waver.

Wall Street could get some insight into the Fed's thinking Tuesday when the central bank releases minutes from its last meeting. On Aug. 7, policymakers held rates steady and said that while tight credit and the housing market may drag on the economy, inflation is the primary risk.

Investors will also be focusing on the Commerce Department's Friday report on personal income, personal spending, and core personal consumption expenditures inflation. Personal income is expected to tick up 0.3 percent, spending is expected to rise 0.4 percent, and the year-over-year inflation gauge is anticipated to register at 2.0 percent, slightly above last month's reading of 1.9 percent.

A FULL SCHEDULE OF ECONOMIC DATA ...

Investors will have a lot of economic data to sift through this week.

Wall Street will be reading two snapshots of the slumping housing market: The National Association of Realtors' Monday report on sales of existing homes, and Tuesday's S&P/Case-Shiller home price index.

Existing home sales are expected to have held fairly steady in July, according to the median estimate of economists surveyed Friday by Thomson Financial, after dropping in June to the slowest rate in nearly five years.

The market will also get two readings on August consumer sentiment this week -- one Tuesday from the Conference Board, and one Friday from the University of Michigan.

Economic growth will be in focus as well. On Wednesday, the Commerce Department releases its second estimate of second-quarter gross domestic product. Economists forecast that GDP growth will register at 4.0 percent, a faster pace than the department's July estimate of 3.4 percent.

And on Friday, the Chicago Purchasing Managers releases its manufacturing index, which is expected to show modest expansion. The Chicago PMI is a precursor to next week's closely watched national manufacturing index from the Institute for Supply Management.

... AND A FEW EARNINGS REPORTS

Dell Inc. releases quarterly results Thursday and is expected to report a second-quarter profit of 30 cents a share. The computer maker closed at $27.74 Friday, at the upper end of its 52-week range of $20.52 to $29.61.

Borders Group Inc. releases its second-quarter earnings Tuesday and is expected to post a loss of 34 cents a share. The book and music retailer closed at $15.80 Friday, at the lower end of its 52-week range of $13.72 to $24.19.

Weekend's Special: The Vatican City

The Vatican City is situated entirely within the city of Rome, sprawling over a hill west of the River Tiber, and separated from the rest of the city by a wall. Vatican City comprises St Peter’s Church, St Peter’s Square, the Vatican and the Vatican Gardens.

The Vatican City is famous for its magnificent St Peter’s Basilica. Near St Peter’s stands the Vatican Palace, the Pope’s residence. Among the principal features of the Palace are the Stanze, the Sistine Chapel and the Vatican Museum, containing major works of art and valuable pictures.

The Vatican City is best known to tourists and students of architecture for the magnificent St Peter’s Basilica. Visitors are normally admitted to the dome, 0800-1700.

Leading up to it is the 17th-century St Peter’s Square, a superb creation by Bernini. On either side are semicircular colonnades, and in the centre of the square is an Egyptian obelisk hewn in the reign of Caligula.

It is also possible to visit the Necropoli Precostantiniana, the excavations under St Peter’s, although permission has to be obtained in advance and is usually granted only to students and teachers with a professional interest in the work being carried out.

The Vatican Gardens can only be visited by those on guided tours or bus tours. Tickets are available from the tourist information office in St Peter’s Square; it is advisable to apply two days in advance. There is a restaurant in the museum and a bar and cafeteria on the roof of St Peter’s.

To the right of St Peter’s stands the Vatican Palace, the Pope’s residence. Among the principal features of the Palace are the Stanze, the Sistine Chapel, the Garden House or Belvedere, the Vatican Library and the Vatican Collections, containing major works of art and valuable pictures. The Museum & Treasure House includes the Collection of Antiquities, Museo Pio-Clementino, the Egyptian Museum, the Etruscan Museum and the Museum of Modern Religious Art.

Weekend's Business Lifestyle: Your Home Sweet Home Decorations

Entrances/Halls
Lasting first impressions

Entrances are the connection between the outer world and the inner world of our home. Behind every front door lurks an area that poses a special decorating challenge.

Depending on the architecture of the building, an entrance may be inherently gracious or, at the worst, devoid of any positive qualities at all. The ideal entry would have the luxury of space, enough to allow more than two people stretching room. And it would have ample light, overhead as well as on the wall, and a mirror for reasons of vanity (a quick look upon arriving or leaving). There would be a closet just for guests, an attractive table to hold flowers, keys, and mail, and space to display artwork. The handsome, practical floor would be tiled, carpeted, or left bare and polished.

The entrance influences our feelings and thoughts every time we either enter our home or go out into the world. Hallways also create a transitional space and should be as free of distracting objects as you can make them, in order to make the transition from the exterior to the interior world as smooth as possible.

Living Room

The living room is a place to work, relax and play. It's also the room where friends and family come together, so it has to be a inviting place to linger.

It's the perfect place to "put yourself out there" and display the art, colors, and collections that you love. Living room decorating speak volumes about your personality and how you view the world, so make it accurate account.

The focus is to express your individuality in any design style that suits you. Furnished with comfort and style, a living room can be a place of refuge at the heart of your home.

The living room is the threshold between public and private life. Create a space that's casual, comfortable, and no matter how you furnish it, your room will always be full of life.

Dining Room

The colors of the china, the shape and size of the table, the tablecloth and napkins, the stemware and flatware, the centerpiece, the dining room lighting, and the greenery all affect the energy and decor. With a few quick variations, you can transform your surroundings into the dining experience you desire.

The best colors for the dining room are beige, cream, green, blue, and soft pastels such as lavender, pink, peach, and apricot. Add bright yellows, oranges, and warm reds to stimulate the palate. Wallpaper, stencils, sponging, and faux finishes create additional texture.

The dining room table is the main piece of furniture in your dining room, the surface that holds your food, dinnerware, and decorations. The shapes and sizes, and materials you place on and around it create a specific energy. Place your dining room table in the middle of the room to allow people to walk around the table and to get in and out of their chairs with ease. If the size and shape of the table and room allow, try placing a rectangular table across the room. Wood tables are strong and stable. Wood warms the space. If your old wooden table needs a fresh look, stain it with a new finish or paint it an antique white or a muted color such as green, blue, or light red.

A comfortable chair encourages leisurely dining. Sturdy chairs with a solid back will support you; add seat cushions for additional comfort and color. Ensure that the view from each chair is a spectacular one, both inviting and pleasing to the eye.

Kitchen

The kitchen of today is a great deal more than work space, it's a living room, a playroom, a office, a refuge, a dining room, and a hub of communications. In order to provide a reassuring and pleasurable backdrop to the ebb and flow of life, a kitchen needs to function well on all these levels.

More than any other room in the house, a kitchen requires forethought and preparation, whether you are designing a brand-new kitchen from scratch, remodeling an existing one, or just sprucing up parts of the kitchen. Thorough planning will enable you to create an attractive, high-performance kitchen that reflects your priorities and personality. Achieving a successful balance between comfort, efficiency, and good looks is the secret of the perfect kitchen. Create the kitchen that works well for your lifestyle.

The most obvious way to pick a design for your kitchen is to let the type of home you live in be a major factor, but you must consider the life you lead. Busy people need small, efficient kitchens; dedicated cooks, on the other hand, will want space to enjoy their art.

Bedroom

Give your bedroom a sensual serenity, turn it to a private sanctuary adding details and treatments that are personal and chic. Bedrooms are meant for sleeping, reading, reflecting, romancing, recharging your batteries , escaping from the cares of the day.The quality of sleeping you receive every day in you bedroom is very important for your happiness, health and productivity.

To create your perfect bedroom, you must think about what you like to do in your bedroom and define a style appropriated. Consider your bedroom like a sacred retreat. It's very important that your connection with every object in your bedroom elicits a positive, nurturing response.A cozy, sensual bedroom atmosphere invites complete rest and rejuvenation of your body, mind and spirit.

Cleanse your bedroom of item that keep negative memories and associations alive, and you find that your bedroom will embrace and revitalize. The comfort and safety you feel in the world is directly connected to how safe and comfortable you feel in your home, bedrooms should be especially so. Here is the place to plunge on fabrics that are sensual, including chenille, flannel, silk, cotton, satin, and velvet.

View from the bed is very important, put a frame, a piece of art, a vase of flowers that inspires you and makes you dream. The art in your bedroom makes a strong impact on your psyche, make it a positive one. Include sensual, serene or romantic images that calm and inspire you. If you want to honor the five senses, focus on creating truly sensual environments. Whether single or coupled, your bedroom should be a place where all yours senses are comforted and intimately celebrated. Light a scented candle, play bedroom music, and relax. This is your oasis in which to have treats that you enjoy.

Bathroom

The bathroom is the place where we retreat ritually for bathing, pampering and relaxing. Make all bathrooms beautiful, whether you're looking for ideas for a new bath or just refreshing your current one, we just give you creative inspiration, and simple, practical advice for large or small bathroom.

Create a comfortable, casual bathing spaces with ease and style just with a fresh coat of paint, new bathroom linens, candles, art and plants. A quick change to the quality of the room's light, accomplished through new window treatments, mirrors, bulbs, or light fixtures themselves, can completely change the atmosphere of the bathroom. Every space offers individual opportunities for style.

Select the fixtures: the sink, tub, toilet and shower. Fixtures are the bathroom jewelry, and show your style. Fixtures are vessels and they come in a variety of materials, shapes, styles, sizes, colors, and finishes. Newly minted designs or reproductions of older ones, you have to choose the fixtures that you love. Selecting the fixtures and fittings is one of the pleasures of planning a bathroom. Even if you're not installing new fixtures, you can still accessorize. The fittings-the tabs and spouts, the faucetry are the jewelry of the bathroom, the decorative hardware that controls, mixes and direct the water flow- they are often made of combination of materials, from metals to semi-precious stones, porcelain and glass. Their range will inspire you to dress your bathroom up or down, according to your own style. Small details count as much as large ones, search for towel bars, drawer pulls, paper holders, medicine cabinets and mirrors that add personality.

Garden & Outdoor Spaces

Patio, decks, balconies, porches and yards are the extension of our living space. From landscaped grounds to the tiniest balcony, nearly any exterior area can be the setting for a comfortable outdoor room. With nice outdoor furniture, your outdoor space can become much more than a backdrop for occasional barbecue; it can be as welcoming as the living room and an integral part of everyday life.

Your outdoor space should be decorated with the same attention to comfort, style, and creativity as any other room. Today you can find new weather-resistant materials and stylish outdoor furniture to create an outdoor space that's truly an extension of the home. Create an outdoor area that truly reflects who you are and the way you live. Outside, a few fruit trees, a flowering pergola, a row of terra-cotta pots, or the curves of a large canvas umbrella set the stage. Your outdoor space has the potential to become your favorite destination for eating, entertaining, relaxing. Select a decorating scheme that celebrates your style, and furnishings and accessories that make you feel at home under the open sky.

BOE Unmoved Despite Money Market Pleas

The Bank of England is continuing to reject the pleas of traders in the sterling money markets by declining to inject liquidity into the U.K. financial system.

And while market sources say this has led interbank borrowing and lending to "grind to a halt" in recent days, the BOE's inaction shows it doesn't yet see any threat to the stability of the financial system.

Moreover, analysts say, the rise in money market interest rates could help the BOE to achieve its main objective of taming U.K. economic growth and inflation, while aiding the re-pricing of risk and asset prices it's long warned is needed.

The interest rates banks charge each other to borrow sterling have risen sharply since credit fears began to permeate the market Aug. 9. But in contrast to the U.S. Federal Reserve, the European Central Bank and the Bank of Japan, the BOE has chosen not to lend freely to banks in an attempt to bring those rates down.

The London interbank offered rate has risen particularly quickly for lending of one month or more. The 1-month LIBOR rate had risen to 6.51% by Thursday this week from 5.94% two weeks ago, while the 3-month rate had risen to 6.62% from 6.1% over the same period. Both rates are considerably above the BOE's current target interest rate of 5.75%.

Even the rates quoted are to some extent guesswork, says one market participant who wished to remain anonymous.

"The sterling money markets have apparently ground to a halt in a way that the euro and dollar markets have not - banks are simply not lending any significant amounts of money, even to other banks, let alone non-financial corporations," he said. "In other words, de facto, there is no sterling LIBOR market - LIBOR rates quoted on screens are really 'plucked out of the air'."

Several market sources confirm that BOE officials, up to and including Executive Director for Markets Paul Tucker, have been in regular contact with trading floor heads, and have been made aware how gummed up the market has become.

"They've sounded out a whole range of market sources, but they're not prepared to act," says a source at one of the U.K.'s leading clearing banks who also wished to remain anonymous.

That suggests that the BOE's fundamental belief is that despite market participants' concerns, it's not yet necessary for them to do more than reassure financial institutions about the availability of its standing lending facility - a system by which banks needing funds can tap the Bank, albeit at a penalty rate of interest.

"The bottom line is that there hasn't been a major failure in U.K. money markets: if there were to be one, the BOE would of course step in," said Julian Jessop, chief international economist at Capital Economics in London.

The Bank of England declined to comment on claims that the money markets had ground to a halt, and suggestions that its officials have had extensive contacts with market participants.

The rise in the cost of interbank borrowing could also have some happy side effects for the BOE in terms of its broader policy objectives.

While the rise in LIBOR rates reflects a "market-specific blockage", according to economists at Barclays Capital, "the market is an important one and the longer it continues the more likely it is that higher funding costs will be passed on to firms and households."

Though it's hard to measure, that rise in borrowing costs should slow broader economic activity. Many on the BOE's Monetary Policy Committee won't mind that. Official figures Friday showed the U.K. economy grew at an annual rate of 3.0% in the second quarter, above its trend rate of 2.75%, and the MPC believes that growth is probably even stronger.

Until the recent market turbulence, the hawks on the MPC - including BOE Governor Mervyn King - had been expected to push for a further rate rise this autumn to cool demand and the consequent pressures on consumer-price inflation, until July above the 2.0% target rate for fifteen consecutive months.

But the rise in LIBOR rates could well have done the MPC's cooling work for it.

"Amid action from the Fed and the ECB to inject liquidity in their interbank markets, the Bank of England has conspicuously not taken any special action," said Diana Choyleva, U.K. economist at Lombard Street Research. "Conspiracy theorists may take pleasure in noting that by inaction the Governor gets his hike without the blame or having to convince the rowdy members of the MPC."

To be sure, the BOE is treading a fine line: it won't want troubles in the financial sector to slam the brakes on economic activity too hard. But it may not mind if the credit crunch leads to less of the risky borrowing that has fueled asset prices in recent years.

Peter Matza, policy and technical officer at the Association of Corporate Treasurers, says evidence from its members suggests that's exactly what's happening. He cites mining giant Rio Tinto's ability to raise $40 billion in debt this week as evidence that investment grade borrowers with good growth prospects won't have their sources of funding cut.

"For sub-investment grade companies and those further down the scale, the issue is much cloudier," he says. "A material deterioration will not benefit the economy, but if it can take the froth out of certain markets, that will be welcome."

Certainly the BOE has been consistent in its comments about market conditions, warning in its April Financial Stability Report that market participants should test their positions to assess how well they would perform during a sharp drop in market liquidity.

Now that has come to pass, there's little sympathy in Threadneedle Street for anyone finding conditions not to their liking.

"The MPC will welcome the re-pricing of risk that is currently underway and the tightening of credit conditions this implies," says Ross Walker, U.K. economist at Royal Bank of Scotland in London. "It would be different if the Bank perceived there to be a threat to the financial system as a whole but, absent this, the Bank is likely to remain on the sidelines, relying on markets
to sort things out for themselves."

IMF Prepared To Act If Effects Of Credit Crisis Worsen

The International Monetary Fund is prepared to meet the needs of economies in distress if the effects of an ongoing credit crisis spread, however, fund officials don't see that as likely at the moment, IMF Managing Director Rodrigo Rato said Thursday.

"I wouldn't give an amount, but the resources of the fund are vast, so I don't think there will be a problem," he said, noting the fund could resort to agreements with world central bank's if it were faced with the necessity. Rato made the comments after a meeting with Brazil's President Luiz Inacio Lula da Silva and Finance Minister Guido Mantega to discuss the world economic outlook and the proposed reform of the IMF. The IMF chief said he remained optimistic that the world economy could pull through the turbulence that has recently assailed major financial markets. "I don't believe we are before the risk of macroeconomic crises, but in the current circumstances we have to be especially vigilant," he said. "We think there will be repercussions in the world economy, but they will be greater in some countries and lesser in others." Rato praised the recent rapid action of major central banks in providing liquidity for world markets. The IMF official, however, also called upon financial institutions to clarify doubts about high risk credit lines that are at the root of recent turbulence. "The lack of confidence in new products requires rapid clarification from financial institutions," he said. "We need to recover confidence and change expectations." Rato said he believed that some smaller economies would be adversely affected by recent market turbulence. "We're not seeing spreading of credit sector risk toward sovereign risk," he said. "Debt spreads have increased but not in a significant way, and they have since corrected." The IMF chief also drew attention to positive growth trends in many European, Asian, Latin American and sub-Saharan countries as a factor that would help overcome the effects of the credit crisis in the U.S. "We can't ignore the positive things in the world economy, which are many," he said. He said that although doubts about the mortgage and credit sectors in the U.S. economy might persist, there was reason to believe those difficulties could be attenuated by other positive aspects of the U.S. economy. "The U.S. is doing well." he said. "It has low inflation, low unemployment, and high levels of investment with a very flexible and dynamic economic system." Regarding reforms at the IMF, Rato said he looked favorably at proposals from countries such as Brazil that would give emerging market countries more influence at the institution. Rato said the fund was concentrating on three themes in the reform, which would include devising a new formula for representation of member countries, creating a new fund investment plan and introducing a new instrument for prevention of crises in emerging market countries that are affected by contagion amid world market turbulence. Among ideas being studied, he said, would be to allow member countries immediate access to between 300%-500% of their participation in the fund in the event of necessity.

PBOC Hints At More Rate Hikes; Warns Against Asset Bubble

In a strong indication that China's central bank will continue tightening monetary policy, People's Bank of China Assistant Gov. Yi Gang said Friday policymakers will resolutely curb inflation and prevent negative real interest rates.

"Negative (real) interest rates in the long term are a distortion to the economy, and aren't good. We should try our best to avoid it," Yi said on the sidelines of an economic forum. He added reversing negative real rates takes time. Yi also said during a speech at the forum that an asset bubble could cause problems, a signal that Beijing remains concerned about soaring share prices. Yi's comments highlight the challenges that the PBOC faces in curbing inflation and taming a stubborn stock market that has so far defied previous rate hikes. Domestic liquidity remains flush because of China's large trade surplus, which also fuels expectations of further yuan appreciation that encourage even more funds to flow into the country. The PBOC Wednesday raised benchmark lending and deposit rates for the fourth time this year, after the consumer price inflation rate rose to a 10-year high of 5.6% in July. The rate hike brought the one-year lending rate to 7.02%, and the one-year deposit rate to 3.60%. Yi said negative real interest rates over the long term could hurt the economy. He added the "central bank's determination to control inflation is unwavering." Low real lending rates fuel investment, raising the risk of excess production capacity, while low or even negative deposit rates encourage local residents to take money out of bank accounts and invest them in the local stock and property markets. China's benchmark share index has continued to post record highs. It crossed the 5000 points level Thursday to close at an all-time high of 5032.49. China should also prevent overly large capital inflows, Yi said. In recent months, China's foreign-exchange regulator has said it will step up checks on funds flowing illegally through trade channels, for which China doesn't have foreign-exchange controls. Yi also reiterated that capital account convertibility is an eventual goal. Earlier this week, the State Administration of Foreign Exchange said it authorized a trial allowing Chinese residents for the first time to directly invest in securities products in Hong Kong, marking a step toward convertibility. But Yi also said China should ensure orderly capital outflows, suggesting that further easing in its capital controls will be gradual. Yi added Asian countries should prevent risks linked to large trade surpluses and strong currencies.

IMF: Global Financial Market Turmoil Receding

The global financial turmoil of the last couple of weeks appears to be receding, but it will have some impact on global growth, International Monetary Fund Managing Director Rodrigo Rato said Wednesday.

Speaking at a press conference in Sao Paulo, he applauded actions of key central banks in meeting a global credit crunch with measures aimed at increasing global market liquidity. "The IMF forecast for global economic growth could be changed slightly, but not dramatically, because of the consequences on the real economy of the recent global financial market turmoil," he said. He said the IMF's current forecasts put global growth at about 5% in 2007 and 2008. Those figures could decrease slightly, he added. On Thursday, Rato will meet with President Luiz Inacio Lula da Silva in Brasilia. Rato said, "Over the last five years, the global economy has seen solid, steady growth as we had not seen in over 40 years." He added the current background of steady growth and sound fundamentals has left the world economy in a good position to absorb shocks sparked by the U.S. subprime mortgage lending crisis and the resulting global credit crunch. He called the recent financial market turmoil "a correction affecting certain assets." Rato said, "The correction will have some consequences on the real economy. Those consequences will be different for different countries depending on their economic fundamentals." He offered Brazil as an example of a country "well positioned because of sound monetary and other policies" to absorb effects of the correction with little or no impact on its economic performance. More broadly, he said the IMF didn't see any systematic impact on sovereign risk from the recent market turmoil, even among emerging market countries. Rato added, "Over the last five years, what we have seen is that, for the first time, a period of sustained world economic growth is being led by an emerging market country, namely China."

M&A Talk Helps Lift Stocks But Not Long-term Solution

Chatter about prospective merger and acquisition deals offered some balm for frayed nerves, but market watchers are still guarded in their outlook for stocks.

For one thing, the deals discussed Wednesday involved strategic buyers, or corporations that can fund acquisitions with cash on their balance sheets. Private-equity players - who have been worst hit by the recent credit crunch that has roiled financial markets - weren't really in the picture. "I don't think the deal flow talk today changes the credit story," said Barry Hyman, equity market strategist at EKN Financial Services. "There are private-equity deals funded by debt, and then there are company deals financed by equity and cash." Two online brokers got attention Wednesday after The Wall Street Journal reported merger discussions between TD Ameritrade Holding Corp. (AMTD) and E*Trade Financial Corp. (ETFC). Also, energy and metals exchange Nymex Holdings Inc. (NMX) said late Tuesday that it has been in talks to merge with other exchanges, confirming months of speculation. Early in the year, a steady flow of massive private-equity deals helped fuel a market rally. But in recent weeks, the private-equity juggernaut has slowed as tough conditions in credit markets made it more difficult for buyouts to get done. Credit markets have refused to fund a number of recent deals at their original terms, forcing banks to take debt on to their balance sheets to get the deals closed. Some high-profile names have been hit. Last month, Cadbury Schweppes PLC (CSG) said it was postponing the sale of its beverages business to a private-equity firm due to choppy credit markets. Early in August, Home Depot Inc. (HD) disclosed it was in talks to renegotiate the terms of the $10.3 billion sale of its supply business to three private-equity firms. Still, some market watchers believe that Wednesday's roster of prospective deals did offer some positive signals. "Today is a great reminder that if we can just improve confidence, there is a lot of buying power that can be brought in," said James Paulsen, chief investment strategist at Wells Capital Management.

Worst of 'Market Hysteria' May Be Over

The Dow Jones Industrial Average was recently up 85 points to 13176, and the Standard & Poor's 500 added 9 points to 1456. "There is optimism there will be deals again, but more importantly, that the whole economic financial system will not implode," said Michael Metz, chief investment strategist at Oppenheimer. He said that more strategic buyers may be willing to make acquisitions as private-equity players have been pushed to the sidelines. "Corporate America is in great shape," said Metz. "With less competition from private equity, they (strategic buyers) are in a position to make more deals, and they will in my opinion." Still, merger news wasn't the only factor in play in Wednesday's market. EKN's Hyman said that stocks are being helped by "anticipation of what a lot of people are starting to call the 'Bernanke Put,' or the anticipation of interest rate cuts that are being built into the market today." Still, Hyman and others are cautious in their outlook. "I’m not sure the decline is over," said Hyman. Any piece of unexpectedly bad economic data could unsettle stocks, he said. Indeed, some of Wednesday news painted a picture that was far from rosy. Toll Brothers Inc.'s (TOL) fiscal third-quarter net fell 85% as the luxury home builder recorded more land writedowns amid continued slowing in new-home construction. Subprime mortgage lender Accredited Home Lenders Holding Co. (LEND) is no longer accepting new U.S. loan applications and will cut more than half its work force as the company deals with the ongoing credit market turmoil. Metz isn't discounting the possibility of more declines, but believes that the worst of the "market hysteria" may be over. "If you get a decline (in stocks), it will be more orderly," said Metz. "Debt markets are signaling that the height of the credit stress is behind us for the time being." Yields on Treasury bills were modestly higher, and Treasury prices dropped sharply early Wednesday, as risk aversion eased somewhat.

Likelihood of ECB Rate Hike Shrinking

The likelihood of the European Central Bank hiking interest rates again in September has shrunk from nearly 100% two weeks ago to just over 50% as credit market jitters persist, according to a poll of bank analysts by Dow Jones Newswires.

That shift received new impulse Tuesday when economic sentiment among German institutional investors and analysts was shown falling off sharply in August, according to the latest poll by Center for European Economic Research, or ZEW. The ranks of ECB-watchers who expect to hold off raising rates amid a global credit crisis are growing quickly. Of 33 financial institutions canvassed, 18 said a September hike of 25 basis points to 4.25% is still likely and 14 said it is no longer likely. One institution said it was too close to call. Only eight of those polled said they expect the ECB's policy rate to move to an even more hawkish 4.50% by the end of the year from 4.00% now. Even those projecting a hike noted there is higher uncertainty about the move given turbulence on financial markets. "At the moment, we still consider it more likely than not that the lessening market turmoil could enable the ECB to still deliver the September move," Bank of America said in a research note. "Still the probability that the ECB will raise rates in September or October has fallen to no more than 60% in our view," Bank of America. On Aug. 2, ECB President signaled a September hike by saying the council is "vigilant" on price risks - a word used to herald all eight of the bank's rate increases since the start to policy tightening in December 2005. But that was before global markets were hit by anxiety that a U.S. liquidity crunch driven by subprime mortgage markets was spilling into Europe and Asia. Over the past two weeks, the ECB and other major central banks have been pumping billions in extra liquidity into money markets to prop up their banking systems. The ECB again Tuesday gave cash-hungry banks extra funds in its regular weekly refinancing operation morning. The ECB allotted EUR275 billion in one-week funds, which is EUR46 billion more than the EUR229 billion 'benchmark' of what the ECB estimated banks need for routine business. Financial turbulence already has darkened economic expectations in some parts of Europe. Earlier in the day, the ZEW German think tank said German economic expectations plunged into negative territory at -6.9 points in August from 10.4 points in July. The reading was steeply lower than economists projections of -3.0 points. The 291 ZEW survey participants cited potential consequences to the German economy if the U.S. mortgage crisis spills over into the economy there, the ZEW said. Economic expectations for the euro zone also fell, with the corresponding ZEW index falling 13.3 points to -6.1 points. "Market turbulence will probably have an impact on the assessment of the macroeconomic outlook," said Silvia Pepino, economist at J.P. Morgan Research, adding that "in a fast-moving environment the outlook is under constant review." The Royal Bank of Scotland revised its euro-zone growth outlook for the fourth quarter of this year, and the first quarter of 2008, bringing the annual forecast for next year down to 2.1%, from 2.3% previously. The bank said it now puts the likelihood of a September ECB hike at just around 30%.

Japan Sees Slowdown In Exports To Major Markets

Japan's trade surplus narrowed in July for the first time in nine months as rising commodity prices pushed up the country's import bill and exports were sluggish to major markets such as the U.S. and Europe.

Government data released Wednesday showed that Japan's trade surplus with its three biggest markets - the U.S., Europe and Asia - all declined last month, the first time that has happened since January 2005. The data could be an ominous sign for the Japanese economy, which relies heavily on exports for growth. Some analysts say that exports could slow further due to weak global demand for Japanese goods amid financial market turmoil, and the recent strengthening of the yen. "Given the recent financial market turbulence, the downside risk to global growth now looks larger than before," said Lehman Brothers economist Hiroshi Shiraishi. The sharp appreciation of the yen over the past few weeks "is an additional risk to Japan's export growth," he said. Data released by the Ministry of Finance showed that Japan's merchandise trade surplus in July narrowed 21.1% on year to Y671.2 billion, larger than the 10.2% fall forecast by private economists. Japan's trade surplus with the U.S. contracted 4.1% on year, its first decline in two months, while the surplus with the euro zone slipped for the first time in 21 months, declining 6.5%. Its surplus with the rest of Asia fell 1.9%. "Until now, the slowdown in exports was mainly seen with the U.S., but this trend may spread to other regions," said Yuji Kameoka, chief analyst at Daiwa Institute of Research. That "would weaken the overall economy in Japan," he said. Exports account for about 15% of Japan's gross domestic product. Although private consumption and corporate capital spending together make up a much bigger portion of the economy, consumption has been sluggish, while capital expenditures may slow after about four years of strong growth. That means that Japan's economy may need steady export growth to continue expanding. But exports might not pick up much with the economic outlook for Japan's biggest markets, including the U.S., cloudy because of the financial jitters stemming from subprime mortgage woes.

Exports To Major Markets Slow

Indeed, Wednesday's data showed export growth to the U.S. slowed to 1.3% in July from a rise of 6.7% in June. Exports to the Euro zone increased 13.1% in July from an 16.3% rise in June, while export growth to Asia slowed to 13.8% from 15.8% in June. "While a big slump is unlikely, risks might be higher than we expect that growth in Japanese exports will slow to a crawl," said Yoshikiyo Shimamine, chief economist at Dai-Ichi Life Research Institute. "It's even possible that lingering instability in markets will hold back stock prices and dent consumer sentiment globally," which could weigh on exporters in Japan, he said. The dollar has been highly volatile against the yen in recent days, falling as low as Y111.60 on Friday from about the Y117 mark earlier last week. A strong yen cuts into Japanese exporters' profits. Meanwhile, global commodity prices such as those of oil have been rising sharply amid global inflation trends, pushing up Japan's import bill. For example, prices of crude oil produced in Dubai, which is mostly used in Japan, reached the $70 level per barrel in July from the $60 mark in June. "It's necessary to keep an eye on market moves" for clues on the future course of Japanese exports and its economy as a whole, Shimamine said.