Fall in US Housing Starts and Permits

U.S. housing starts declined a further 6.2% M/M in August, falling to 895K from 954K in July. The decline was much worse that the drop to 950K expected by the markets, and comes on the heels of the 12.4% M/M drop in July. This is now the lowest number of new residential construction since January 1991.

Building permits approved during the month were also lower, falling 8.9% M/M to 854K, following the massive 17.7% M/M drop to 937K in July. Market consensus was for a drop to 928K.

On the whole, the report highlights the distress that the U.S. housing market continues to face. However, with the rescue of the two major U.S. GSEs appearing to have provided some semblance of normalcy in the U.S. mortgage insurance and securitisation business, there is perhaps the possibility that these dramatic declines in starts and permits in the past few months may not continue indefinitely.

Trichet Retains Hawkish Tones

The ECB's balancing act goes on. However, whereas the August press conference dwelled on the weakness of growth more than had been anticipated, today's press conference and statement returned the source of greatest concern to the unacceptably poor inflation outlook.

The range for projected CPI inflation next year shows a higher mid-point of 2.6% versus 2.4% in the previous forecast made in June, and it is entirely above 2.0% at 2.3-2.9% versus the old band of 1.8-3.0%.

It seems premature of markets to anticipate an ECB rate cut later this year or even in early 2009. The baseline CPI ranged that the ECB envisages for next year lies entirely above the target ceiling of 2.0%, and risks surrounding that prediction are skewed to the upside based on both the bank's analysis of economic data and monetary and credit growth trends and levels. To be sure, those risks could moderate in time. Commodity prices may not turn back upward. Moderation seen already in money and credit growth could pick up speed. Gauges of expected inflation based on traded futures and other data may settle back, and wage awards could develop in a more acceptable way than officials fear. That's a lot of ifs that will take time to verify. To be sure, Trichet and his colleagues expect inflation to dip back under 2.0% by 2010, but that is too long an interval to merit policy action at this time.

A month ago in August, ECB officials admitted that real GDP had weakened in mid-2008, which was a downgraded assessment from July's assertion that activity “remains broadly in line with our expectation of moderate ongoing growth.” The assessment was downgraded again today to “experiencing an episode of weak activity..” Without using the R-for-recession word, new growth forecasts clearly embody that possibility.

The ECB will not wait until CPI inflation is 2.5% or less before cutting interest rates. I believe officials will hold their fire at least until 2009 and not act until they are confident that core inflation is on a sustainable downward course. They already have resisted any urge to act at the first sign of recession. Odds of back-to-back quarters of negative growth climb day by day. July's Euro-zone volume of retail sales was already 0.8% lower than the 2Q level, which nearly matches the 2Q-over-1Q drop. The composite PMI has moved below 50. Consumer confidence is very depressed, business sentiment is worsening more sharply, construction is in full crisis in several members of the bloc, and export demand is being depressed. The declines in the euro and oil are not yet far enough to deliver relief. Real German orders slumped 3.8% (14.4% saar) in 2Q and were another 3.8% lower in July than the 2Q mean, and domestic orders for capital goods, a harbinger of German business spending in coming months, posted monthly drops of 1.8% in June followed by 3.9% in July. Only an eternal optimist would think Euroland will avoid recession. The ECB policymakers are not eternal optimists. Sometimes a recession is what it takes to restore stable prices. Sometimes a recession is exactly what monetary officials believe is what needs to be engineered. Former Fed Chairman Volcker waited a full 12 months into a very deep recession before starting to loosen America's extraordinarily tight monetary policy in mid-1982, and that's not the only example that proves this point.

Many market pundits have been critical of the ECB, comparing its inertia to Bernanke's quick and aggressive easing, which averted negative U.S. growth in 1H08. Such pundits assert that currency markets are now punishing the euro in response, and that is fine with ECB officials. Monetary restraint, in their opinion, had been too heavily concentrated in an overvalued euro and not sufficiently represented in the level of interest rates. The euro's slide since mid-July helps reorder that imbalance.

BoE and ECB Rate Decision

The journey continues, yet today both the United Kingdom and the Euro Zone will face their judgment day, with both Central banks have to decide whether to keep their rates steady which is most likely to take place; but the highlight will be headed toward Mr. Trichet speech to see what would be his comments after we saw growth contracting for the first time since the Euro was established.

First Decision: Euro Zone

It's the second rate decision after the ECB decided to hike rates to 4.25% just to anchor the elevated inflationary level, but those levels continued trading in above the ECB comfort zone. When commodity prices began to ease in late July till today pressures eased slightly and according to the CPI flash estimate which was released last week inflation in August will ease down to 3.8% from the previous 4.1% yet those levels remains away from the ECB comfort zone.
But the situation did not stop at those elevated levels; the conditions in the Zone got augmented to the levels where exports got curbed due to the surge in oil and Euro prices, in addition to the lost confidence between citizens stopping them from spending money according to the retail sales data that came in at contraction levels in the past three months. The down turn was obvious in the second quarter, when most fundamentals flipped its direction from the 'sound' stage used by Mr. Trichet into weak levels with some dipping into a contraction, which came in at the end with Germany, Italy and France the leading three economies facing a contraction in growth dragging the overall zone into -0.2% second quarter growth. As we are now looking closely into the third quarter data, we clearly saw some improvement in fundamentals that would prevent the Zone from falling in a contraction in the third quarter, yet more confirmations are needed especially for the September data.

Second Decision: United Kingdom

Not like the Zone; United Kingdom is facing more complicated impediments, falling housing market, deteriorated household incomes from the surge in consumer prices along with contracting manufacturing and services sector is what the Britons are facing. The step taken by the Mervin king saying in his quarterly inflationary report that the Kingdom will face stalling growth with increasing signs that next year growth will hold at a flat reading or a contraction in two quarter. But the problem that the BOE had no space to cut rates at the time being because the threats of rising prices continue to weigh upon the royal lands. Expectations that the committee would be holding steady rates today at 5.00%, just to see when inflation would ease down slightly so they will start putting a rate cuts into a consideration just to escape the fears of recession, yet personally I don't think that a cut would be seen this year, as they need more confirmations from easing commodity prices if it will hold at those low levels compared to the unprecedented levels that were seen in July.

Finally: The United States
The best of the worst that's what markets consider the United States; according to what occurring in the past two economies investors' believe that the states are the safest because they ended the cutting rates journey, even when their housing market did not face a bottom yet; but now they are waiting for the most suitable time to start hiking rates once again in order to contain the elevated consumer prices. A bunch of fundamentals are released in the States, at first we will start with the ADP Employment change which measures the number in employment in the services sector, expectations that the services shrank in August due to increasing signals of the global slow down is having its affect on curbing those industries. The median estimate falls at a falling employment by 30 thousand in August from the previous incline in of 9 thousand, the issue that recently this reading got discarded due the extreme revision taking place each month making an entrusted reading. But what might gives us an indication about tomorrows reading and if the Unemployment sector will remain to weaken or not is the jobless claims which as to be released later this day, with expectations that claim inched lower this week to 420 thousand from the previous 425 thousand claims. So finally today we've got the ISM Non- manufacturing reading which measure the willingness of consumer to investor their money in the business and the services sector, expectations that confidence is not restored back again because the ISM reading is still under the 50 barrier, as expectations points out that in August the levels will be holding at 49.5 levels not changing from the previous.

So it's a heavy loaded day, the European, the Britons and the Americans are all heading their full concentration into markets to see what fundamentals will revel to us today.