While issues such as the Japanese earthquake, the Libyan civil war and the European debt crisis keep investors on their toes, Rob Langston considers the implications....

Europe
Few were surprised at the decision by the European Central Bank (ECB) to increase interest rates for the first time in almost three years by 25 basis points to 1.25 per cent.

Analysts had long predicted it but the rate hike couldn’t have been worse timed, occurring to a backdrop of yet another bailout for one of the Eurozone’s PIIGS (Portugal, Italy, Ireland, Greece & Spain) economies.

The Portuguese were forced to seek a £70 billion bailout to meet debt repayments just days after Prime Minister Jose Socrates resigned, having failed to push through tough new austerity measures.

The bailout follows similar handouts to Greece and Ireland and has posed several questions of the strength of the Spanish economy.

However, the ECB’s decision to increase interest rates was driven more by a desire to combat inflation with the move most likely to hit the bailed out economies of the Eurozone hardest.

Germany –which is shouldering much of the responsibility of keeping the Eurozone afloat – was thought to be the biggest beneficiary of the rate hike.

The German economy has performed much more robustly than its Eurozone partners and continues to experience strong growth.

This move has also prompted renewed questions over the UK base rate, which was last month held at 0.5 per cent by the Bank of England’s Monetary Policy Committee (MPC) – the rate has now been held at the all-time low for more than two years.

The MPC has found itself under pressure to raise interest rates as a combination of relatively high inflation and a low interest rate environment eats into savings rates.

Elsewhere in the world, the Libyan conflict has continued to rumble on with African Union leaders last month seeking a ceasefire between the Gaddafi-controlled army and rebel forces.

So far, the conflict has lasted longer than other pockets of unrest in the region and has played a role in keeping the price of oil high as security of Libyan oil fields remains in question.


Emerging Markets
Eyes continue to be focused on emerging markets countries, as the MSCI Emerging Market index grew by 5.9 per cent in dollar terms during March.

The aptly name Mike Sell, manager of the Thames River Global Emerging Markets Fund, says the region’s resilience supports a more bullish mid-term market view. ‘India rose 11.1 per cent following signs that wholesale interest rates were peaking.

Indonesia rallied due to better than expected inflation numbers and the rally in bond markets eased equity investor concerns,’ he says.

‘The Central Bank also indicated a willingness to let the currency strengthen to control inflation.’

Sell adds, ‘In China, fears of a hard landing eased with increasing evidence of moderating inflation and hopes that monetary tightening would abate.’

Richard Titherington, chief investment officer of emerging markets equities at JP Morgan Asset Management, says plenty of opportunities remain in the infrastructure sector.

He explains, ‘Emerging market countries will benefit from sustainable long-term trends in the coming years and infrastructure will play a significant part in future growth.

‘Urbanisation is driving increased productivity and prosperity across emerging markets, while the cement and steel sectors have seen a high volume of growth of late and will continue to face a greater demand from these countries.’

Titherington adds, ‘Emerging market companies currently account for 15 per cent of global corporate profits and, with over 700 emerging market infrastructure related companies available to investors, the long term outlook for growth remains positive.’

Bonds
Sovereign debt investors will have been paying particularly close attention to events in Portugal last month.

However, Chris Iggo, chief investment officer of fixed income at Axa Investment Management, says markets had ‘barely reacted to the news’.

He says some of the high yields from short-dated government bonds issued by PIIGS countries currently available on the market could provide a good opportunity for investors if growth remains strong.

 ‘The ECB has made it clear that high government bond yields are not its problem but inflation is,’ Iggo adds.

‘Thus it will raise rates until it is comfortable that policy has been tightened sufficiently to impact on inflationary pressures.’

In the UK it may be some time before the Bank of England contemplates a similar move, according to Iggo.

‘Perhaps the doves on the MPC will hold out for even longer than another month and it may take continued inflation misses, a weaker bond market and some reversal of sterling’s recent strength to persuade them to shore up the Bank’s monetary policy credibility,’ he adds.

US equities
The US economy is being watched closely by the rest of the world as the Federal Reserve begins to withdraw stimulus from the economy, with no further rounds of quantitative easing on the cards.

John Greenwood, chief economist at Invesco Perpetual, says although economic data coming out of the US has been broadly positive in recent months, there are still concerns in some areas of the economy.

Housing, non-residential construction and the labour market, he says, have been the worst performing areas of the economy during the recovery, although employment has begun to pick up recently.

‘For the year as a whole, I expect real GDP growth of 3 per cent with headline CPI inflation of 1.8 per cent,’ says Greenwood.

‘Provided that corporate profits can continue increasing at a healthy rate, this combination should be positive from an investment perspective.

‘However, the withdrawal of QE2 and the prospect of gradual tightening of fiscal policy could prove challenging for risk asset markets in the second half of 2011.’