Central Bank Interest Rate Outlook

Central Bank Interest Rate Outlook

Written by Sonu Sadarangani, DailyFX Research

Highlights of Latest Policy Meetings:

Federal Reserve

In a statement released on June 22, 2011, the Federal Open Market Committee announced its decision to maintain its target interest rate between 0.00 and 0.25%, a level held unchanged since December 2008. The discount rate, at 0.75%, remains at a level below the 1% historical spread from the fed funds rate.

According to information received from the Committee’s most recent meeting, “economic recovery is continuing at a moderate pace, though somewhat more slowly than the Committee had expected.” Two significant factors contributing to the slow recovery include high food and energy prices and supply chain disruptions following the Japan earthquake. The housing market continues to remain weak as well. However, there are bright spots signaling economic recovery. Household spending and business investment in equipment and software showed strong gains. Additionally, the Fed has been able to achieve its target inflation rate of 2%, primarily due to higher prices of commodities and imported goods.

Looking ahead, the FOMC “seeks to foster maximum employment and price stability consistent with its statutory mandate.” Unemployment currently remains at elevated levels and inflation needs to be stabilized as it climbs beyond the target level. The unemployment rate rose unexpectedly in June to 9.2% from 9.1% in May. The Committee expects a gradual decline in unemployment as the pace of economic recovery picks up in the second half of 2011 and inflation to ease once food and energy prices subside. The Committee revised GDP and unemployment forecasts downwards from April projections. The change in GDP forecasts for 2011 and 2012 have been revised from 3.3% to 2.9% and from 4.2% to 3.7%, respectively. The unemployment rate, previously forecasted to drop to 7.9% by 2012, is expected to remain above 8% for the period.

Slower than expected recovery and “a subdued outlook for inflation are likely to warrant exceptionally low levels for the federal funds rate for an extended period.” Although QE2 ended on June 30, 2011, the Fed will continue to buy treasuries under its asset purchase program. The next rate decision meeting will be held on August 9, 2011 and “the Committee will continue to monitor the economic outlook and financial developments and will act as needed to best foster maximum employment and price stability.”

FOMC Statements and Calendar at: http://www.federalreserve.gov/FOMC/default.htm#calendars

European Central Bank

At its meeting on July 7, 2011, the Governing Council of the European Central Bank (ECB) decided to increase the key ECB interest rates by 25 basis points to 1.50%. In his introductory statement following the meeting, ECB President Trichet elaborated on the bank’s action to increase the key rate level stating “the underlying pace of monetary policy expansion is gradually recovering. Monetary liquidity remains ample, with the potential to accommodate price pressures in the euro area. All in all, it is essential that the recent price developments do not give rise to broad-based inflationary pressures over the medium term.” The recent rise in energy and commodity prices have contributed to rising prices in the euro area reflected in the 2.7% June HICP inflation figure. With the ECB’s objective of keeping inflation below, but close to 2% in the medium term, Trichet addressed these inflationary concerns stating “our decision will contribute to keeping inflation expectations in the euro area firmly anchored in line with our aim of maintaining inflation rate targets.” Trichet continued further on the ECB’s objective saying that “this [objective] is a prerequisite for monetary policy to make an ongoing contribution towards supporting growth and job creation in the euro area.”

Data revealed real GDP growth of 0.8% in the first quarter of 2011, quarter over quarter, a marked increase over the 0.3% growth in the final quarter of 2010. “Recent statistical releases and survey-based indicators point towards a continued expansion of economic activity in the euro area in the second quarter of this year, albeit at a slower pace.” This is indicative of the interest rate remaining at 1.50% over the medium term. Although expansion of the global economy should help the euro area, the Governing Council’s assessment states that risks to the economic outlook “remain broadly balanced in an environment of elevated uncertainty.” The June 2011 Eurosystem staff predicts an annual real GDP range of 1.5% to 2.3% for 2011 and a range of 0.6% to 2.8% for 2012.

Aside from the monetary policy changes, Trichet emphasized the need for effective fiscal policies and structural reforms in the different euro zone economies. “The implementation of ambitious and far-reaching structural reforms is urgently required in the euro area to strengthen substantially its competitiveness, flexibility and longer-term growth potential. This is particularly relevant for countries with high fiscal and external deficits or with past losses in competitiveness,” Trichet concluded.

ECB Statements can be found at: http://www.ecb.int

Bank of England

On July 7, 2011, the Bank of England’s Monetary Policy Committee voted to maintain the official Bank Rate paid on commercial bank reserves at 0.5%, leaving it unchanged for the 28th straight month. The Committee also voted to maintain the stock of asset purchases financed by the issuance of central bank reserves at £200 billion. The bank rate has remained at 0.5% since March 5, 2009, when it was lowered 50 basis points to its current level. The asset purchase program was initiated on March 5, 2009 and a change has not been made since a £25 billion increase took place on November 5, 2009. Although the country’s inflation rate decreased from 4.5% to 4.2% in June, it is still more than double its target of 2%. Given the high rate, policy makers at the Bank of England agree that the economic outlook is not stable enough to withstand higher interest rates. Traditionally, an inflation rate of this level would be a signal for the MPC to increase the bank rate but policy makers believe that inflationary pressures “will ease once food and oil prices come down.”

GDP for the 3 months ending in June rose only 0.1% versus a 0.4% increase in the 3 months ending in May. A key concern for policy makers has been the dismal outlook for consumer spending. In the first quarter of 2011, household spending fell by 0.6% in real terms. Growth in spending is expected to increase gradually in the second half of 2011 and into 2012. Although earlier reports showed that employment had picked up in the first quarter of 2011, a survey released on July 13 revealed jobless claims rose more than anticipated, rising 24.5K, topping the expected 15.0K figure.

Looking ahead, it is evident that the Bank of England’s MPC is focused on economic growth rather than reducing inflation. With economic recovery expected to be shaky in the short and medium term, the MPC will likely hold the bank rate at 0.5% through the end of 2011. The next scheduled Monetary Policy Meeting will be held on August 4, 2011.

BOE Statements can be found at: http://www.bankofengland.co.uk/monetarypolicy/decisions.htm

Swiss National Bank

At the Monetary Policy Assessment on June 16, 2011, the Swiss National Bank (SNB) announced its decision to maintain the target range for the three month Libor at 0.0-0.75 percent, and intends to keep the Libor within the lower part of the range around 0.25 percent. The underlying reason for leaving rates unchanged was concern of a surge in the Franc. Policy makers at the SNB are worried that an appreciated Franc could hurt exporters. Although several European economies have been tightening their monetary policies, SNB’s Hildebrand said at the briefing in Bern that “downside risks predominate” with the Franc’s ascent among the main threats to exports and growth. The Swiss currency has appreciated 33 percent versus the dollar in the past year. “Despite the strong appreciation of the Swiss franc, the economy continues to benefit from robust international demand, “the central bank said today. “However, margins in the export industry are coming under increasing pressure.” Inflation is not an immediate concern for the region as statistics indicate consumer prices rose 0.3 percent in May from a year ago.

Going forward, the SNB forecasts predict inflation rates of 0.9 percent for 2011, 1.0 percent for 2012 and 1.7 percent for 2013, assuming the Libor rate is kept unchanged at 0.25 percent. In light of the forecasts, the current monetary policy can be sustained in the short to medium term. As inflation rises in the longer term towards the end of the forecast horizon, maintaining the current policy will not be possible without “compromising price stability.” Signals point to strong economic growth over the next year. Manufacturing growth rose sharply in May, leading economic indicators are at five year highs and unemployment has dropped to 3 percent. Furthermore, the SNB expects a growth in real GDP of about 2 percent.

SNB Monetary Policy press releases can be found at: http://www.snb.ch/en

Reserve Bank of Australia

At its meeting on July 5, 2011, the Board of the Reserve Bank of Australia decided to leave the cash rate unchanged at 4.75%. The rate has been maintained at this level since November, when it was increased from 4.5%, marking the longest period without a rate change in four years. The primary reason underlying the decision was a slowdown in the pace of recovery in the June quarter stemming from dampening effects of high food and energy prices and supply chain disruptions following the Japan earthquake. Europe’s ongoing sovereign debt crisis has added uncertainty to financial markets. Employment growth in the first two quarters has been gradual and has not significantly changed the unemployment rate which stands at 5%. CPI inflation for the year is forecasted to be higher than expected largely due to extreme weather events earlier in the year.

Looking ahead, “investment in the resources sector is picking up strongly in response to high levels of commodity prices and the outlook remains very positive.” With signs of recovery in investments and in a number of service sectors, the long term outlook calls for an above average change in GDP. In the medium term, stagnant unemployment and a global economic downturn have resulted in a weaker than expected growth forecast for Australia through 2011. As a result, the cash rate is expected to remain unchanged through this period with any change occurring near the end of the year when economic recovery is expected to pick up at a stronger pace. The next meeting is scheduled for August 2, 2011 where “the Board will continue to assess carefully the evolving outlook for growth and inflation.”

RBA Statements on changes in monetary policy can be found at: http://www.rba.gov.au/

Bank of Canada

At its May 31, 2011 monetary policy meeting, the Bank of Canada announced its decision to maintain its target for the overnight rate at 1.00 percent. The Bank Rate is correspondingly 1.25 percent and the deposit rate is 0.75 percent. In its most recent Monetary Policy Report (MPR), the focus is on analysis of global economies. The report indicates that recovery “is proceeding broadly as expected.” Challenges mentioned in the report include the worries of inflationary pressures due to rising commodity and energy prices, but “despite the challenges that weigh on global outlook, financial conditions remain very stimulative.” In Canada, GDP rose by an annualized rate of 3.9 percent in the first quarter, meeting analysts’ expectations. The Bank expects total CPI inflation to remain above 3 percent in the short term with a convergence to 2 percent by the middle of 2012 as “excess supply in the economy is gradually absorbed, labor compensation growth stays modest, productivity recovers and inflation expectations remain well-anchored.”

Looking forward, the outlook for the Canadian economy is generally positive. Factors pointing to near term growth include increased household borrowing and spending and the “persistent strength” of the Canadian Dollar. An interest rate hike at the next meeting in July seems unlikely but signals from the meeting suggest there could be hikes before the year end. Previous statements from the Bank mentioned that future rate hikes “would need to be carefully considered.” The Bank added in this statement that“to the extent that the expansion continues and the current material excess supply in the economy is gradually absorbed, some of the considerable monetary policy stimulus currently in place will be eventually withdrawn, consistent with achieving the 2 per cent inflation target.”

BOC press releases on monetary policy: http://www.bankofcanada.ca/en/monetary/target.html

Reserve Bank of New Zealand

The Reserve Bank announced on June 8, 2011, the decision to leave the Official Cash Rate (OCR) unchanged at 2.5 percent. Following the release of its March Monetary Policy Statement, the economy has improved and the economic outlook is optimistic. In the aftermath of the Christchurch earthquake, “reconstruction in Canterbury is projected to add about 2 percentage points to GDP growth over 2012, and boost the level of activity for several years after.” The increased economic activity will also boost employment growth in the region, with the unemployment rate expected to drop to 4.5 percent. The statement also mentioned that “wage inflation will pick up as economic activity recovers and excess labor capacity is absorbed.” The rise in wage and rising commodity and energy prices are the underlying reasons for the Bank’s projection of a 2.4 percent inflation peak in early 2012. A greater concern for the Bank lies in the strengthening New Zealand Dollar, which reached its highest level against the USD in more than two decades in June 2011. Governor Alan Bollard voiced his concerns, stating that “it was negatively affecting other parts of the tradable sector and would inhibit rebalancing in the New Zealand economy.”

Going forward, New Zealand’s robust economic growth will allow the Bank to withdraw monetary policy stimulus in the latter part of 2011. In the first forecasts released since the earthquakes, the Bank expects the economy to grow at 4.4 percent on the year in the March 2012 and 3.6 percent in the March 2013. In the statement released by the Reserve Bank, Governor Bollard stated that “A gradual increase in the OCR over the next two years will be required to offset this [inflation], such that CPI inflation tracks close to the midpoint of the target band over the latter part of the project. “

RBNZ calendar of upcoming announcements can be found at: http://www.rbnz.govt.nz/monpol/statements/0092224.html

Bank of Japan

At the Monetary Policy Meeting held on July 12, 2011, the Policy Board of the Bank of Japan unanimously voted to maintain the uncollateralized overnight night rate at 0.10%. The rate has been kept unchanged since December 2008 when it was cut 20 basis points. Although the economic effects of the earthquake continue to linger, “production has recently shown clear signs of picking up with the easing of supply-side constraints.” Domestic private demand, household and business sentiment and the YoY change in CPI have increased, further providing signs that the economy is on its path towards recovery. Industrial production rose to 6.2% in June on a month over month basis, up from 5.7% in May. An upturn in these important indicators of economic health has improved the employment situation in Japan as well. The unemployment rate dropped to 4.5% in May, down from 4.7% a month earlier.

Although the economy shrank more than anticipated in the first quarter of 2011, easing supply-side constraints and increases in production should lead the way for moderate recovery from the second half of fiscal 2011. Improved economic conditions overseas should accelerate recovery as well. Change in Real GDP is expected to be 0.4% for fiscal 2011, revised downwards from the 0.6% forecast made in April. For fiscal 2012, forecasts remained unchanged from April with a 2.9% change in Real GDP expected. Risks to growth continue to include deflationary pressures and global economic uncertainty due to the ongoing European debt crisis. The “impact of the earthquake disaster on Japan’s economy still requires due attention.” The BOJ’s focus going forward will be on these risks to growth, signaling that “the bank will continue to carefully examine the outlook for economic activity and prices, including the effects of the disaster, and take appropriate policy actions as necessary.” In light of this “the Bank of Japan is expected to maintain its ultra-loose policy bias for at least another year.” The next scheduled Monetary Policy Meeting will be held on August 5, 2011.

BOJ calendar of monetary policy meetings can be found at: http://www.boj.or.jp/en/mopo/index.htm/