The euro’s surge against the US dollar and sterling partly reflects a view that the Eurozone economy will “decouple” from expected US and UK weakness. Interesting then that the latest business surveys convey exactly the opposite message. While the US Philadelphia Fed and UK CBI manufacturing surveys remained upbeat in September, Eurozone purchasing managers have become markedly more bearish. Complacent ECB officials may soon suffer a rude awakening.

Mostly for fun, in 2002 we calculated a “three bears forecast” for the FTSE 100 index based on the average performance of UK stocks during and after the three largest bear markets of the last century: 1929-32, 1936-40 and 1972-74. Much to our surprise, the “forecast” has proved a remarkably accurate guide to the broad trend in the market – see chart.

Significant deviations from the forecast path have represented buying or selling opportunities. For example, the FTSE overshot the three bears by 10% in April 2006 but subsequently corrected sharply to close the gap.

At the recent August low the FTSE was 13% below the forecast – the largest downside deviation since the current bull run started in 2003. This appears to have been another buying opportunity, with the three bears suggesting the index will return to 6700-6800 later this year.

Simplistic historical comparisons are bound to break down at some point but the economic, liquidity and sentiment backdrop still seems consistent with higher prices.

The Federal Open Market Committee’s decision to lower the Fed funds and discount rates by 50 b.p. represents a bold attempt to forestall the negative economic impact of recent financial market dislocation. Visibility is low and there is a risk that the Fed has jumped the gun – current economic indicators remain consistent with expansion and market stresses were starting to abate before the surprise move. The consensus is convinced that further cuts will follow but a scenario of “one and done” should not be ruled out. Remember August 2005 in the UK?

Annual consumer price inflation fell further to 1.8% in August but the old retail price measure rebounded to 4.1%. The gap between the two is the largest since September 2000. The recent widening mainly reflects accelerating mortgage interest costs, which are included in the RPI but not CPI. Mortgage bills rose by 30% in the year to August.

On our calculations the average interest rate on outstanding mortgages stood at 6.0% in August, up from 5.3% a year before. Based on currently quoted rates and the large number of borrowers needing to refinance expiring fixed rate deals, the average rate is likely to reach over 6.5% by early 2008 – see chart.

The surge in mortgage bills will be a significant drag on consumer spending but may result in RPI inflation remaining above 4% going into 2008. With the labour market tightening recently, the MPC will be wary of a compensating pick-up in wage settlements when the pay round kicks off early next year.

Some economists are starting to talk about rate cuts before year-end but I think the MPC is on hold for the foreseeable future.