Currency volatility becoming a key factor in forming market sentiment

AS the FTSE 100 hit a year high last Friday, the debate going on among British and Irish analysts is whether the markets have run ahead of global economic recovery.

Since March, markets overall are up by well over 20%, a move that followed the end of the Iraqi war.

The move in the markets had been forecast by some and was underpinned by an increasing view of recovery in the US becoming a reality after three years of virtually zero growth.

Currency volatility is becoming a key factor in market sentiment, however, analysts have pointed out.

That was seen last week when a number of US economic measures came in better than expected and yet neither the dollar nor the markets showed any great bounce.

In Britain and the US, increasing evidence of a boost in the number of day traders suggests a return of optimism. But analysts point out that the global economy is in a Catch 22 situation as the US presses hard for stronger currencies in Japan and China.

In Europe, where growth will be less than 1% for 2003, a strong euro is working against eurozone recovery and the conflicting demands on currencies may send the markets sideways for a few months.

In Britain this week, investors will take their cue from drugs and drinks companies for evidence of whether firms can repeat the earnings revival shown by US counterparts.

With the British economy expected to grow by between 2 and 2.5% and the US by about the same figure, the shift towards a more positive stock market view has already begun.

In that context, the level of jobs generated in the months ahead will be crucial and could prove to be the next test of nerve for the bulls who believe global economic growth is underway.

Crucial jobs have been missing from the recovery story so far. That factor remains a deep-seated concern for analysts trying to judge how real economic momentum in the US has become.

The fear for investors is that jobless economic growth will be short-lived.

Also, concern exists that unless the rest of the world begins to recover, the green shoots emerging in the US will not blossom to full-blooded growth.

Over the weekend, investors said that without doubt strong third-quarter earnings from US companies had lifted optimism.

“There is a lot factored into some of these prices now, but what is encouraging is that there’s still a lot of positive surprises, and analysts haven’t fully factored in the operational gearing,” said Derek Mitchell, director of British equities at Isis Asset Management.

“In the past two years companies have been ripping costs out, so when you start to see a recovery it feeds through very quickly to the bottom line,” he added.

The buoyant mood lifted the FTSE 100 share index to a 14-month high of 4,383 points last Wednesday, before easing back to around 4,340 mid-morning on Friday.

That was an increase of 0.6% on the week and a rise of more than 6% already this month.

Dealers still fear, however, that the rally had gone too far, too fast, and was still holding the FTSE in check.