Effects of ECU Currency Basket Revision

On September 21, 1989, the Spanish peseta and the Portuguese escudo will be incorporated into the currency basket comprising the European Currency Unit (ECU). As a result, all of the currencies of the twelve Member States of the European Community (EC) will then be included in the ECU. Whenever the ECU currency basket is revised, care is given to maintaining the external value of the ECU, at least over the short term, there is apt to be a rise in ECU interest rates.

The European Currency Unit occupies a central position with the European Currency System (EMS). It is the denominator for the exchange rate mechanism, the basis for calculating the divergence indicator, the denominator for operations in both the intervention and credit mechanism, and a means of settlement between the monetary authorities in the EC. Technically speaking, the ECU is a currency basket, which as of September 21, 1989, upon the inclusion of the peseta and escudo, will consist of the twelve EC currencies.

ECU An Artificial Currency

The calculation of the value of an ECU in U.S. dollars is shown in Table 1 for September 17, 1984, the last time the ECU currency basket underwent revision. The value is the sum of the amounts listed in column 3. As of September 17, 1984, the ECU thus amounted to US$ 0.73016. By using the procedure shown in Table 1 for computing the US$/ECU market rate, the ECU can be converted into any other EC currency.

Originally, the weighting of the individual currencies in the ECU basket depended on their shares in interommunity trade, the share of each Member State in the gross national product (GNP) of the EC and the shorterm EMS currency standby quotas. The EC has not gone as far as to precisely set the calculation of the currency amounts. Nevertheless, computations have shown that currency amounts develop nearly parallel to the share of a country's currency in the EC's GNP and its internal trade. Calculations of this type also back up the assumption that EC nations with strong currencies, such as West Germany and the Netherlands, are overepresented in the ECU currency basket. In this way, the EC attempts to strengthen investors' confidence in the stability of the ECU. Periodic Revision of the ECU Currency Basket

The ECU basket of currencies is subject to periodic revision. The reason for this is the distortion of the basket weightings that stem from exchange rate fluctuations and the inclusion of new currencies in the EMS.

The ECU currency basket was last revised in September 1984. The revision was necessary owing to the inclusion of the Greek drachma in the basket and the alteration in the relative importance of the various currencies. As columns 1 and 2 of Table 2 show, the amounts of the harder currencies were reduced in the 1984 ECU revision, whereas the amounts of the softer currencies were raised. In this manner, the share of the Dark, for example, as the principal currency in the EMS was lowered back to 32% of the ECU's value (see Table 1) after it had risen from the creation of the EMS to about 37% as a consequence of the frequent revaluations and devaluations of other ECU currencies. In the meantime, further currency ups and downs have, as the chart shows, caused new changes in basket weightings. At present, they stand at 34.9% for the Dark, 19.0% for the French franc and 11.9% for the British pound on the basis of the ECU central rates in the EMS.

On June 16, 1989, the EC Finance Ministers tentatively set the new weightings for the currencies in the ECU basket for the period from September 1989 to September 1994 (see Table 1, last column). In this second revision since the establishment of the EMS, the Spanish peseta and the Portuguese escudo will be included in the basket. The new weightings will go into force as of September 21, 1989. The exchange rates quoted the day before will be the determining factor in calculating the amounts of the national currencies. If Spain and Portugal had already been included in the ECU currency basket on June 30, 1989, the currency amounts would have been those shown in Table2, column 3, provided no change in the ECU value had taken place.

Currency Basket Revisions and ECU Value Stability

The revision of the ECU currency basket has no immediate influence on the value of the ECU, as the amounts of the currencies are set in such a way that the ECU rate remains unchanged, at least over the short term. This simply means that the sum of column 3 in Table 1 remains constant before and after the revision of the currency basket. The revision does, however, influence the development of the ECU exchange rates as time goes on. When comparing the actual US$/ECU exchange rate trend with the hypothetical performance of the currency basket in its original 1979 formation (i.e., without the drachma), it can be seen that the 1984 currency basket revision only affected the ECU exchange rate over the medium term. The actual US$/ECU exchange rate currently lies about 1.5% below the rate that would have existed had the Greek drachma not been included in the ECU currency basket in 1984.

The inclusion of the relatively soft Spanish peseta and Portuguese escudo this coming September could exert a much stronger influence on the value of the ECU than the incorporation the Greek drachma did. Accounting for 7.1% of the EC's GNP (1988; in ECU) and over 4.4% in EC internal trade (average of share in exports and imports), the peseta will have a weighting of 5.3% in the ECU currency basket. However, with the inclusion of the Spanish peseta and the Portuguese escudo, the share of the hard currencies (the Dark and the guilder combined) in the ECU basket will decline from 45.9% to 39.5% the future development of the ECU's exchange rate therefore depends strongly on how much Spain's economic policy is aligned with EC discipline. If Spain moves in the direction of inflation, it will become even more difficult for the Dark to maintain stability in the EMS. The strength of the peseta in the EMS will depend on whether Spain's socialist government can bring the new flarep of inflation in Spain under control (6.9% in June 1989), whether the budget deficit can be reduced (1984-1988: 5% of the GNP) and whether the hefty trade balance deficit can be pared back.

Whether the escudo can hold its own in the EMS depends mainly on Portugal's ability to get a grip on its inflation and budget deficit (1984-88: 9.3%). Although Portugal has been able to reduce its annual inflation during the last five years from 27.8% to 9.4%, the current 13% upswing in consumer prices is considerably above the EC average.

Effect of Currency Basket Revision on ECU Interest Rates

The inclusion of soft currencies in the ECU currency basket has the effect of gradually pushing up interest rates on the ECU market. The size of an increase as a consequence of a currency basket revision can be seen, for example, in the difference between the actual ECU interest rate and an artificially compiled reference rate, which is calculated on the basis of the currency basket weightings used up to now, that is, until September 16, 1984, before the entry of Greece. However, the development of this interest rate difference possesses informative value only when it is possible to establish that the trends of the actual interest rate and the reference rate were largely identical prior to the revision of the currency basket. This agreement can be achieved on the basis of arbitrage transactions. However, in the sector of longerm ECU credits, significant differences between market yields and the theoretical average value can be expected from time to time. The independence accompanying the yields on ECU issues results from the fact that the arbitrage on the markets for these issues does not function as smoothly as in the case of bank deposits owing to market imperfections, such as inadequate levels of liquidity, etc. Moreover, fully developed issue markets do not exist for all of the basket currencies. Marked differences between the actual and the artificial ECU reference interest rates can occur especially just before a currency basket revision. Depending on the expected changes in the composition of the ECU currency basket, the speculative discounting of the revision can cause ECU interest rates to rise or fall without altering the basic variables. For these reasons, estimates of the effects of basket revisions on interest rates must be viewed with caution.

Despite the various problems invariably encountered, we have attempted to show the influence of the inclusion of the Greek drachma in the ECU currency basket in September 1984 on the nominal and real ECU interest rates in the shortand longerm sectors. The results show that the artificially constructed reference interest rate and the actual threeonth ECU bank deposit rate for the period from January 1982 to June 1984 have virtually the same average value (1% probability of error). A comparison of the ECU market rate with the reference or theoretical interest rate shows that the actual threeonth ECU deposit rate averaged 0.24 of a percentage point above the theoretical ECU interest rate between September 1984 and June 1989. This can be interpreted to mean that since September 1984 borrowings in ECUs have become 24 basis points more expensive in nominal terms. The average spread between the actual ECU interest rates in real terms and the artificial ones is 0.39 of a percentage point for the same period. Inflation accounts for 15 basis points.

The influence of the currencies of Spain and Portugal, which are countries with high interest rates, on shorterm interest rates is likely to be stronger than was the effect exerted by the inclusion of the Greek drachma. We believe that as of September 1989, the actual threeonth ECU deposit rate will be about 85 basis points above the artificial reference interest rate, which does not take into account the Iberian levels of inflation (that is, the reference interest rate this time takes into consideration all of the EC countries except Spain and Portugal). Comparable calculations have been made for ECU yields in the longange sector. But insufficient data and the speculative discounting of the basket revision make it difficult to arrive at meaningful conclusions. Nevertheless, we are of the opinion that the spread between actual and theoretical ECU yields (excluding Spain and Portugal) has been expanding since 1987. In 1989, it amounted to an average of 0.49 of a percentage point. The full extent of the spread after September 1989 may be just under one percentage point if we entertain the same assumptions as in the case of the threeonth ECU deposit rate. Naturally, the ECU bond rates will not soar upward on September 21, 1989. As mentioned, the inclusion of Spain and Portugal will be discounted. After the entry date, the appreciation of the EMS hard currencies and their stronger weighting in the ECU currency basket will ensure that the previous rise in interest rates will be partly offset by the currency basket revision.

Conclusion

The inclusion of the Greek drachma in the ECU currency basket in September 1984 raised the level of nominal interest rates by an average of about 0.24 of a percentage point. The inclusion of the Spanish and Portuguese currencies in the basket on September 21, 1989, could have a stronger effect, as the weighting of the Iberian currencies in the ECU basket will be four and a half times that of the drachma in the autumn of 1984. As mentioned, we believe that the shorterm ECU market interest rate after the incorporation of the Iberian currencies will be about 85 basis points above the artificial ECU reference interest rate (without taking the peseta and escudo into consideration). Over the short and medium terms, the ECU exchange rate will probably remain unaffected by the forthcoming currency basket revision.

The Impact of High Interest Rates on the Swiss Economy

Since mid-1988, the Swiss National Bank has maintained a tight hold on the money supply in order to contain the recessionary forces arising from the greater threat of inflation in the wake of the stock market crash in 1987. As a result, interest rates turned sharply upwards. By dampening corporate investments, consumer spending and the Swiss export volume, there is every likelihood that the outbreak of inflation which has since materialized will be brought under control over the medium term.

Tight Money Supply in Order to Combat Inflation

Up to June 1989, interest rates for shorterm investments in Switzerland soared to nearly 8%. The last time such high interest rates were registered under similar restrictive conditions was at the end of 1981 and the beginning of 1982. Longerm interest rates also rose sharply: for instance, the average yield on Swiss federal government bonds temporarily hit the 5.4% mark in June, while interest on 3ear mediumerm notes went up to 5.5% and rates for first mortgages to 6%.

This interest rate trend can be attributed to the Swiss National Bank's inflationighting policy since mid988. By directly curtailing volume and, in turn, the interest rate spiral, the SNB plans to trim its previously overexpansive money supply to conform once again with the demand for money. A larger money supply was also provided by the commercial banking system, since the banks had greater monetary resources at their disposal owing to the relaxation in Switzerland's liquidity regulations and the new Swiss Interbank Clearing (SIC) system. The demand for money is dependent on the volume of goods and services produced, on the financial system (usual modes of payment, liquidity regulations, the moneyreation options open to the commercial banks) and, last but not least, on nominal interest rate and anticipated inflation levels. When interest rates are high, there is less demand for money since it is more worthwhile to effect interestearing investments that bear interest than to have loose cash around that provides no return at all. The demand for money also eases when inflation is on the rise, as nominal interest rates are driven upwards. The SNB's restrictive policies are mainly aimed at the real economic components integral to the demand for money. If the Swiss central bank is successful in trimming its money supply growth in line with the increased quantity of goods, then goods and services prices will be prevented from continuing their climb over the long term due to the resulting shortage of available funds for payment.

Less Capital Spending Activity

Rising interest rates very quickly affect capital spending programs. Such investments are outlays for goods (equipment, plant) that only provide return benefits at a later date. By way of contrast, consumer spending is purely designed to satisfy present requirements. The return on capital spending depends, on the one hand, on the costs the price of the investment goods in question, interest on the capital employed and, on the other hand, on the anticipated income additional revenue and volume of products manufactured using the new capital goods. By means of a capital expenditure account, future flows of funds are discounted and the projects with the highest positive net cash values realized. If interest rates rise, the project net cash values decline, so that the number of worthwhile projects (in terms of total capital spending amount) diminishes.

In Switzerland, a negative connection between interest rates and capital investments has been empirically confirmed. In our estimates, we have taken the average yield on federal government bonds as being the yardstick for interest rates and calculated longerm elasticity of real construction outlays at 0.13 in response to interest rate fluctuations. If, for instance, average longerm interest rates rise from 4.23% to 4.88%, as was the case in the 1st quarter of 1989, this can be expected to result in the real capital spending growth rate, based on the national accounts, diminishing by just under 2% over the following two years. The influence of the other components in the capital expenditure account, such as prices, costs and sales volume are assumed to be constant for the purposes of this single analysis of interest rate fluctuations (ceteris paribus).

In actual fact, the influence of the latter components on capital spending growth is significantly stronger than the impact of interest rates, so that positive sales or price prospects can easily counteract the negative interest rate effects. During its quarterly survey in June 1989, the UBS Economic Research Department queried Swiss companies on the influence of interest rates on their capital spending programs. Only 16% of the firms surveyed anticipate negative repercussions from currently high interest rates on their capital investment projects for 1990, while the remaining 84% were unconcerned about interest rates dampening capital spending sentiment. In the building sector, on the other hand, more than half of the construction firms participating in the survey forecast sharply curtailed construction activity especially in the homeuilding sector due to higher interest rates. These results are only partly valid as a contradiction of the aboveentioned empirical investigation since the companies in question were also taking into account the effect of anticipated brisk demand and other factors relevant to their capital spending programs.

Slowdown in Consumer Spending

Consumer spending not only depends on disposable income and savings, but also on the level of available finance and income that will be generated in the future. Secure jobs and higher income expectations are enough to boost consumer spending in the present, since this anticipated increase in future income provides a sense of assurance. Amid an interest rate uptrend, consumers will tend to spend less in the present, while focusing more on savings and postponing their consumption plans to a later date.

In Switzerland, the negative interest rate effects generally last for nearly a year before the positive delayed reaction takes place. The longerm narrowing of real private consumption growth rate that resulted from the 1% increase in the yield on Swiss federal government issues amounts to .08%. The surge in the average federal government bond yield from 4.23% to 4.88% in the 1st quarter, by itself, has probably led to a 1% reduction in private consumption. Here, too, the impact of interest rates is less pronounced than the effect of other consumerelated factors such as current and anticipated real disposable income.

Higher Swiss-Franc Rate and Lower Exports

Among the fundamental factors of influence on exchange rates are purchasing power and interest rate differentials between currencies. Currencies of countries with relatively low inflation and/or high real interest rates tend to appreciate. From a longerm viewpoint, after the Swiss National Bank has achieved its goal in the fight against inflation, the more favorable inflation differential between Switzerland and other countries will, according to the purchasing power parity theory, result in gains in the Swiss-franc rate. Viewed over the short term, Switzerland's high interest rates due to monetary policy considerations have already generated a flow of capital into Switzerland, since the Swiss franc represents an attractive investment currency based on the improved interest return. As a result, the Swiss currency's former weakness can be overcome and the way paved for an advance by the franc. Experience has shown that, in the case of Switzerland, interest and inflation differentials visis West Germany are the most important factors in this respect, while the influence of dollar interest rates on the Swiss franc is significantly weaker by contrast. If, under these circumstances, the Swiss franc gains faster than the inflation differential in relation to other countries, "overshoots" in effect, then with some delay the growth of Swiss exports will be curtailed. Actual empirical proof of interest rates in Switzerland exerting this "export effect" is not available, however, as no satisfactory exchange rate model currently exists on which to base the study.

The End Effect: Decelerating Inflation

All the accumulated effects on capital spending, consumption and exports will combine to weaken demand for goods and services and therefore result in an economic slowdown in Switzerland. The previously unsatisfactory supply situation the reason for rising prices is sufficient to offset the slacker demand, leading to a slowdown in the price spiral. The entire process beginning with the tightening of the money supply and ending with inflation being reined in is estimated to last more than two years. At the same time, there is also the risk that external shocks, e.g., a recession abroad, could overaccentuate the otherwise easing of demand or that inflation spurts from abroad, e.g., via oil-price increases, could throw the SNB's plans out of gear.

Paradoxically, the ultimate success of this antinflation policy can only be achieved, in an initial phase, by a shortived rekindling of inflation. This can be attributed to the controversial but legally sanctioned connection between mortgage rates, on the one hand, and apartment rents and agricultural prices, on the other hand. As it is impossible, during an extremely broadased interest rate uptrend, to maintain a steady mortgage rate level, homewners are faced with higher costs which they subsequently pass on, at least partly, to their tenants. A similar mechanism is operative in the agricultural sector. As a result, the Swiss index of consumer prices in which apartment rents command an 18% weighting will accelerate temporarily, leading to higher wages and salaries via costfiving increases, thereby setting a shortived wage and price spiral in motion over the short term. Therefore, inflation in Switzerland will rise from its current level of 3% to between 4% and 4 1/2% by the end of the year; the annual average inflation rate for 1990 is also projected to persist at around 4%. The first successful results of the current restrictive monetary policy on the inflation front will only become visible towards the end of 1990 after the 2ear period of delay has run its course.

Stock Market

Swiss Stocks: Attractive Service Sector

Since the beginning of the year, the international stock markets have been characterized by impressive rallies. Almost two years since the stock market crash, confidence in the equity markets appears to have largely returned, although certain sceptics warn that another collapse is on the way. But the current market undertone is sold. In particular, the soalled risk premium, i.e., the additional yield demanded on top of riskree Swiss federal government bonds, is fluctuating at a healthy level. Owing mainly to profitaking or a wait-and-see posture on the part of key market participants, it is a fairly normal development for major rallies to follow in the heels of consolidation phases. The economic environment including the present interest rate trend is favorable for stock investments.

Banks and insurance companies account for more than one third of the Swiss performance index and, aside from the chemical industry, are the most important segments on the stock market. Bolstered by the generally favorable market sentiment and the betterhanxpected corporate earnings results for the current year, banking equities snapped out of their lethargy and rebounded on a broad front. Despite this rally in the banking sector, the bank index has only gained on a par with the composite market average since June. Compared with the beginning of this year and especially since the early months of 1988, this index is still lagging sharply behind the market average. The recent gains insufficiently reflect the brisk corporate earnings momentum. Whereas heavier emphasis on securities and foreign exchange business has already led to a revival in this sector, fresh impetus will be generated by an expansion in lendings and slightly lower money market rates over the medium term. Against this background, we recommend the large fullervice or universal banks. Their intention to be more accountable in their activities and relatively modest multiple (P/E ratio, yield, intrinsic value) are boosting the three major Swiss banks to a very favorable risk/reward ratio.

Insurance companies are also in the focal point of investor interest. In view of "Europe 1992", with Swiss insurance companies having been granted access to this integrated market now that an insurance accord has been concluded with the EC, there is vast growth potential in this sector. Any loopholes in their distribution network can be closed, on the one hand, by takeovers and, on the other hand, by establishing strong links with partners already commanding a broad share of the respective markets. The expansion strategies of both "Winterthur" and "Zurich" insurance groups appear to be particularly promising; therefore, their equities feature among our top picks in this segment.

Money and Capital Markets

Still Conflicting Interest Rate Signals

During the summer months, there was a lack of a clear interest rate trend on the international financial markets in terms of both duration and geographical area. In the United States, in particular, initial hopes of an interest rate downswing following a significant economic slowdown were subsequently neutralized by improved economic indicators. On the other major markets, interest rate fluctuations remained within narrow limits, although the general trend pointed slightly upwards. Aside from the economic fundamentals, the dollar's renewed firming also played a key role in this respect.

Economic Indicators Leave USA Blowing in the Wind

As early as July, economic indicators in the USA pointed to the probability of recessionary forces at work. As, at the same time, inflation was milder than the widespread anxiety justified, interest rates came under pressure in anticipation of the Fed relaxing the monetary reins. Even the Fed appeared to take the fears of a recession more seriously by providing hardly any resistance to the interest rate downswing. At the beginning of August, the commercial banks trimmed their prime rates by 1/2 percentage point to 10 1/2%. Thereafter, however, a series of surprisingly positive economic indicators resulted in a changed perspective as far as the economic and interest rate trend is concerned. Consequently, both money and capital market rates turned upwards once again by roughly 0.4%.

On the non-American markets, the interest rate trend charted an independent course. For instance, the still favorable economic outlook and fairly stable money market rates in West Germany triggered a slight overall rise in bond market yields. In Britain, on the other hand, bond yields came under pressure although money market rates also remained constant owing to the sharp deceleration in economic growth; but news of a drastic widening of the British trade gap subsequently brought this downtrend to a standstill. Furthermore, in Japan, despite an ongoing economic boom, capital market rates underwent a surprisingly steep downturn due to the less pronounced inflation fears that followed in the wake of the yen's temporarily firmer trend.

Still Inverted Interest Rate Structure in Switzerland

The 1/2% cut in Swiss money market rates in July, triggered by falling U.S. interest rates and a temporary dollar lapse, was nearly recouped by a subsequent rebound in August. Between the beginning of July and the beginning of August, 3onth Eurofranc rates eased from 7 3/8% to 6 7/8%, before recuperating to 7 1/4% by the end of the month. As far as domestic economic factors are concerned, the interest rate trend was not subject to any significant new impulses. The still favorable business cycle and the prospect of higher inflation although less pronounced than originally feared induced the Swiss National Bank (SNB) to maintain its restrictive course. The benchmark for measuring the SNB's monetary policy fluctuated throughout the summer months between Fr. 3.5 and 3.2 billion amid an overall downward tendency.

Effective June 30, the major banks cancelled their agreement governing time deposits in Swiss francs. Time deposit rates are now being fixed by the banks independently of each other. In so doing, they accepted a recommendation by the Cartel Commission, although under this agreement the major Swiss banks only adjusted their time deposit rates to the interest rate trend on the Euromarket. After an initial upturn, UBS time deposit rates moved largely in line with Eurofranc rates by displaying a firmer trend in midugust following a preceding decline. At the end of August, interest on 3onth deposits amounted to 6 3/4%, while 4 to 12onth maturities yielded 6 1/2%.

As a result, shorterm interest rates remained considerably higher than yields on the capital market, which was only subject to minor fluctuations over the summer months. Only towards the end of August did a slight uptrend materialize. The undertone on the domestic issues sector of the capital market was generally favorable, as was reflected by latest federal government offering in midugust: not only did the return to maturity fall below the average yield on Swiss federal government issues (5.10%), but the face value of this offering was also increased to Fr. 285 million. Furthermore, the surging stock market boosted several new warrant issues. Since the traditional issuing break was not completely observed on the domestic market this summer, the volume of new bond issues floated on the market was relatively high at Fr. 1.2 billion in July and Fr. 1.4 billion in August. Conversely, the market for Swissranc issues by foreign borrowers remained muted, with most of the activity focusing on private placements.

Precious Metals

Minor Price Fluctuations

During the summer months July and August, precious metals prices displayed a lack of volatility. Owing to milder inflation and the robust dollar, speculative demand for gold almost came to a standstill. The resulting tendency to weakness on the part of the yellow metal resulted, however, in brisk industrial demand, so that major price setbacks failed to materialize. In July, gold was initially bolstered by periodic inflation anxiety and a temporary dollar lapse, as well as by central bank chairman Greenspan's later statement in Congress that the Fed was not oblivious to the threat of recessionary forces at work. In August, there was almost no upward momentum. Conversely, favorable foreign trade data, positive inflation signals in the USA and an unexpectedly firm dollar increased the pressure on gold. The other precious metals were unable to free themselves from gold's downward pull and also tended weaker.

On August 31, gold was listed at $ 360 per ounce, silver at $ 5.08 per ounce and platinum at $ 472.50 per ounce.

Foreign Exchange Market

Frequent Changes in Sentiment

Over the summer months, the situation on the foreign exchange markets has stabilized significantly. Although conflicting signals by U.S. economic indicators triggered several changes in the direction of the dollar rate, the U.S. currency's weekly fluctuations in July and August were substantially less pronounced than in the preummer months. Aside from the uncertainty with regard to the U.S. economic outlook and the Federal Reserve Board's future monetary policy course, events on the foreign exchange markets were mainly characterized by the political shock waves in Japan and strikes in Britain.

Rollercoasting Dollar

Exchange rate trend $/Fr.: 1.6685 (July 1), 1.5950 (10th), 1.6670 (18th), 1.5885 (Aug. 2), 1.7005 (17th) and 1.6875 (31st). After several economic indicators in July hinted at the possibility of a recession breaking out in the USA, the markets began to anticipate a relaxation of the monetary reins by the Fed. The dollar was subsequently exposed to selling pressure. Although the coverage of short positions sparked a rebound, the dollar sustained a further setback on news of unexpectedly negative trade data for May. The dollar's dip was further accentuated by Fed chairman Greenspan's statement that the U.S. monetary authorities were more concerned about a recession than they were about inflation reigniting. At the beginning of August, a trend reversal materialized, with the dollar advancing in response to the betterhanxpected U.S. employment figures. This rally gained momentum when other data seemed to confirm the theory that the U.S. economy would undergo the hopedor soft landing. Another positive aspect affecting the dollar was the widespread nonntervention activity by the central banks.

Yen Burdened by Political Factors

Exchange rate trend $/Yen: 143.75 (July 1), 138.40 (7th), 142.90 (18th), 135.95 (Aug.2) and 144.55 (31st). In July, the yen's fundamental plus points were offset at times by the political instability in Japan. The ruling party's election setbacks both in Tokyo and nationwide, as well as the resignation of prime minister Uno, resulted in the yen losing ground against nonollar currencies. In August, yen cross rates were able to recoup some of their losses following profitaking, but declined against the surging dollar despite intervention on the part of the Bank of Japan. Dark Steady Overall

Exchange rate trend $/DM: 1.9475 (July 1), 1.8475 (Aug. 2) and 1.9565 (31st). DM/Fr.: 85.67 (July 1) and 86.25 (Aug. 31). The effects of the key interest rate increase at the end of June, expectations of declining dollar interest rates and revived international investor interest in West German securities boosted the Dark to significant gains against the dollar up to the beginning of August. But a turnaround subsequently materialized, sparked by the dollar's autonomous strength and the ousting of CDU general secretary Geissler.

Prices in Switzerland

Annual Inflation Steady at 3%

In July 1989, the Swiss index of consumer prices registered a 0.2% month-to-month decline to 114.9 points (December 1982=100). Owing to a seasonal dip in prices for fruit and vegetables, the foodstuffs index category eased by 0.6%. Furthermore, lower prices for gasoline and heating oil resulted in a decline in the heating and lighting (1.0%) and transportation (0.6%) categories. Prices of domestic goods remained stable compared with the preceding month, but rose by 2.8% on a yearoear basis. Annual inflation in connection with imported merchandise still amounted to 3.4% despite a 0.9% monthoonth decline in July. Overall, the annual inflation rate in July persisted at 3.0%.

There was less inflation impetus at the wholesale level. In July, the wholesale price index eased by another 0.3% to 180.1 points (1963 = 100) following its 0.4% decline in June. Within the space of a year, wholesale prices have gained by 4.2% (domestic goods +3.4%, imported merchandise +6.4%).