Central Bank Watch
By John Kicklighter, Currency Analyst and DailyFX Research Team
Highlights of Latest Policy Meetings:
Federal Reserve
The Federal Open Market Committee’s announcement for a 75 basis point cut to the Fed Funds rate came as little surprise to market participants and analysts. Despite being the largest single, scheduled rate cut from the policy body since Paul Volcker was chairmen, many still considered the policy shift as modest – suggesting conditions in the economy and financial market are dire. Now at 2.25 percent, the Fed has lowered the benchmark lending rate a cumulative 300 basis points to its lowest level since January of 2005. A look through the monetary policy statement that accompanied the rate decision confirms these suspicions by simply noting, “recent information indicates that the outlook for economic activity has weakened further.” This is very few words for a growing problem. Through the fourth quarter, the economy grew a modest 0.6 percent on an annualized basis – matching the worst pace in five years. However, this lagging data may not give a true sense for how bad conditions are. More timely data has shown that both the manufacturing and services sectors (the largest components of the corporate sector) have contracted in recent months. The concerning decline in these two groups alone is likely evidence enough to confirm a contraction in GDP through the first quarter of 2008; though the downturn in the consumer sector will likely ensure at least one quarter of negative growth. Employment contracted two consecutive months for the first time since May/June of 2003; and has in turn led the outlook for consumer sentiment to plunge to its lowest levels since 1974.
The threat to the economy aside, a greater concern among policy makers seems to be the state of the financial markets – though the FOMC’s mandate suggests growth and the health of the economy are priorities for making policy. In the recent policy statement, the Committee raised its concern over the state of markets in saying they “remain under considerable stress;” and giving their concerns scope, suggesting “the tightening of credit conditions” would contribute to a cooling of growth. However, these few words once again don’t seem to fully divulge the Fed’s concerns. In the past few months, the central bank has announced a surprise 75 basis point rate cut to avert a potential stock market crash, bailed out Bear Stearns to prevent a collapse in credit markets and stepped up its liquidity injections to try and promote lending among nervous financial institutions. Despite the aggressive rate cuts and all the supplementary actions however, volatility and credit markets have not improved. In fact, they have actually deteriorated despite the efforts. This would suggest that the Fed is on a path to return rates back to the post-tech boom of 1.00 percent or lower. However, the decision to lower rates further will not be so easily made considering the upside pressure in inflation. The Fed noted “inflation has been elevated, and some indicators of inflation expectations have risen.” Such an observation is based on the consumer price index which has held at or above 4.0 percent for four consecutive months through February. What’s more the core reading has run above the central bank’s 2.0 percent target rate for years and upstream inflation pressures measured through the PPI hit their highest levels in 27 years. Such concerns no doubt contributed to the voting board members Fisher and Plosser to vote for less aggressive action at the March meeting. If the economy and financial markets fail to respond to the Fed’s policy actions and inflation keeps its course, fears of stagnation will grow louder.
FOMC Statements and Calendar at http://www.federalreserve.gov/FOMC/default.htm#calendars
Bank of England
At the conclusion of its April 10th meeting, the Monetary Policy Group voted to cut the UK’s benchmark lending rate by 25 basis points to 5.00 percent. This was the third cut – following the December and April efforts to ease – since the credit crisis took hold of the financial markets and global economy last summer. This move clearly shows where the United Kingdom stands in the world as a potential investment destination considering that the BoE is only one of three of the major’s central banks to pursue an active, dovish policy. The only other policy authorities lowering their rates are the Bank of Canada and Federal Reserve – both of which have not only shown consistency in easing policy, but have also taken to 50 and 75 basis point cuts respectively. Whether the BoE follows suit with this unfavorable trend remains to be seen; but speculation that consistent easing is in the works will certainly play a role in guiding the pound until these fears are either confirmed or denied. In addition to the rate announcement, the April decision further came with a short statement from the MPC. In the brief, the group took note of the lingering threat of rising inflation pressures. By the bank’s account, the consumer price gauge rose 2.5 percent in the year through February. What’s more, they projected pressures would “rise further this year, reflecting the continuing impact of higher energy and food prices, as well as the recent depreciation of the sterling.” Considering the BoE targets a 2.0 percent annualized pace of consumer-level inflation, the specific concern surrounding the upside of risks to price growth seems reasonable. However, headline price growth is still well off the 3.0 percent-plus levels from last year that forced Governor Mervyn King to write a letter to the exchequer explaining what was being done to control inflating pressures. What’s more, the outlook for rising prices is based largely upon volatile commodity costs which have been rather efficiently absorbed by producers so far.
Outside of the atypical news release that accompanied the central bank’s rate decision, the factors playing into the outlook for policy action were clearly calling for dovish moves with a mind to a jump in medium-term inflation forecasts. With the series of rate cuts the group has put in for, it is obvious that there is greater concern over the health of domestic growth. In fact, in the government’s most recent growth report, the economy reportedly cooled to its slowest pace of expansion in three years. This was no surprise considering the deterioration of consumer spending, the housing market and trade. In the past few months, the physical trade balance slipped to its worst short fall since records began. From within the country, consumer demand was marred by confidence levels hitting 16-year lows. The sharp plunge in the housing market has been even more threatening for spending habits though. Brits have watched the value of their homes evaporate at its quickest pace in decades over the past few months – lending some credibility to an IMF report that suggested the UK housing market was 33 percent overvalued at the beginning of the year. These economic components aside though, the BoE was likely most concerned with the ongoing credit crunch which threatened not only economic growth but the stability of the financial markets as well. Taking a cue from the ECB and Federal Reserve, the BoE took a more creative approach to shoring up the financial markets in a Special Liquidity Scheme that would accept high-grade asset backed securities as collateral for Gilt swaps that could last from one to three years. Whether or not these effort bears fruit may decide the central bank’s policy direction for the next few months.
BOE Statements can be found at http://www.bankofengland.co.uk/monetarypolicy/decisions.htm
Swiss National Bank
Since breaking a hawkish cycle of eight consecutive rate hikes in December, the Swiss National Bank has shown the market that it is more concerned with growth than many market analysts and market participants had initially thought. On March 13, 2008, the policy authority voted to keep the target three-month Libor rate in a band between 2.25 and 3.25 percent. Taking its cue from a global trend in interest rate policy, the SNB has eased off its hikes as a chill settles over the global markets and threatens to cool the Swiss economy with it. Seeing the potential impact of fading export activity and reduced business activity, policy makers revised their growth estimates lower. For 2008, the central bank forecasts GDP growth of 1.5 to 2.0 percent, where they had projected 2.0 percent in their last monetary statement. In fact, the concern over growth has grown to the point were projections of multi-year high, 2.0 percent inflation through the same period has not been overlooked in favor of growth and financial market operations. This neutrality seems to suit the policy group well considering the European Central Bank has similarly restrained itself from further interest rate hikes since the summer of last year. It is broadly thought that the SNB follows the ECB’s lead as Switzerland is heavily dependent on the Euro Zone for growth and inflation. Therefore, if the ECB continues to hold its rates at current levels, then this may very well mean that the SNB’s own Libor rate will remain unchanged for some time as well.
While the projections for growth are cautious, recent data out of the Swiss economy would suggest the SNB could still have scope for rate hikes. Overall, the economy was steaming along at a 3.1 percent pace through 2007 – making it the fourth year in a row expansion has exceeded its long-term growth rate. The labor market continues to support the consumer sector. In fact, the employment level over the fourth quarter has beat expectations by growth 2.7 percent. What’s more, inflation has ballooned to levels not seen in many years. Upstream producer and import prices are growing at a 3.0 percent annualized rate thanks to high costs for raw materials. More importantly, front line, consumer-level inflation has been saddled with more of the burden as the CPI has accelerated to a 14-year high 2.4 percent. However, in regards to these considerable trends, the SNB has suggested they will not last for long. As growth in major trade partners starts to par back, Switzerland will begin to respond sluggishly on its own through medium term. This can already be seen in a number of indicators. Investor confidence, highly sensitive to the growth outlook, has dropped to lowest levels on records. This makes sense considering the KOF leading indicators composite index continues to ease of its highs. Going forward, it will be important to take note of the ECB’s monetary policy bias as the monthly meetings will act as a good gauge for whether the SNB could be gearing up for a hike to thwart inflation come its next meeting in June.
SNB Monetary Policy press releases can be found at http://www.snb.ch/e/aktuelles/
Reserve Bank of Australia
Indeed, conditions in Australia appear sanguine compared to the US, as the nation registered its 17th consecutive year of economic growth. GDP accelerated 4.3 percent in the third quarter from a year earlier, driven by strong export demand for natural resources in Asia. In fact, Australia's trade deficit narrowed in December by more than expected while companies increased shipments of natural resources like coal, and farm products like wheat and wool. The resilience of foreign export demand and the subsequent increase in output by producers has helped to tighten Australia’s labor markets, as the unemployment rate has fallen to a 33-year low of 4.3 percent and wage increases have served to boost disposable income for consumers. As a result, households continue to spend at will, which has been a boon to the services sector but has also added to already-buoyant price pressures. Inflation hawks in Australia have been on edge for some time, and after the RBA’s weighted-median index of inflation jumped 1.1 percent in the fourth quarter - pushing the annual rate of growth to a 16-year high of 3.8 percent - a February rate hike was essentially guaranteed.
Going forward, it is anticipated that tighter credit conditions in foreign markets will lead export demand to cool this year, as Governor Stevens noted in his policy statement that, “the world economy is slowing and it now appears likely that global growth will be below trend in 2008.” Domestically, the RBA suggests that previous policy tightening actions “can be expected to exert a moderating influence on private demand in Australia over the period ahead,” which has led 19 of 27 economists polled by Bloomberg News to says that they did not see the central bank making another interest rate move again this year. However, the RBA is still considered to hold a hawkish bias, as Governor Stevens also said, “given the extent of pressure on capacity and the build up in inflation, a significant slowing in demand from its recent pace is likely to be necessary to reduce inflation over time.” With the support of newly elected Prime Minister, Kevin Rudd, who recently said, “As a government, we believe the fight against inflation must come first,” the RBA is highly unlikely to turn to a more neutral policy stance until CPI figures start to fall lower.
RBA Statements on changes in monetary policy can be found at http://www.rba.gov.au/
On December 4th, the Bank of Canada’s monetary policy group joined the Federal Reserve as the second major central bank to put an official end to a former regime of steady rate hikes by lowering its benchmark lending rate. The 25 basis point cut to a target of 4.25 percent marked the first expansionary shift from the central bank since April of 2004. Looking at the same economic data that the monetary policy board was considering during its meeting, the decision for a cut was standing on a few sturdy fundamental legs. Looking at the health of the economy, the growth has cooled through its most recent reading. According to Statistics Canada’s figures, expansion cooled from a 3.8 percent pace in the second quarter to 2.9 percent. And, while this clip is still stronger than the relatively depressed activity from last year, it still lags most comparable G10 and commodity and export based economies. For the past few years, shipments abroad of manufactured goods, autos and raw materials have been the fuel that has gotten the Canadian economy up and running. However, the export sector is quickly changing from boon to burden. Though steady demand and high prices for commodities remains, most other trade-related groups have suffered the burden of expensive input costs and a Canadian dollar at record highs. Indeed, the physical trade surplus dropped to C$2.6 billion in September, its lowest reading since 1998. The third quarter current account balance (a broader measure of trade flows) was heading in the same direction when it reported a C$1.0 billion surplus – its worst reading in four years – from C$6.4 billion the previous period. Economic data aside, the inflation statistics were what allowed the central bank to actually pursue a cut to accommodate growth. Core consumer inflation in the year through October cooled to a 1.8 percent clip, a 16-month low and below the BoC’s target of 2.0 percent.
What’s more, despite (or perhaps because of) the economics surrounding this decision, the quarter point cut caught both analysts and market participants off guard. A Bloomberg consensus showed most economists were not expecting the policy meeting to result in any substantial alteration to the Bank of Canada’s monetary policy statement – much less the first rate cut in years. Only three meetings ago, in July, the Bank of Canada hiked the overnight lending rate and kept its language rather hawkish making note of upside inflation pressures, strong consumer spending and a healthy housing market. Looking to the December statement, the rate bias was clearly upset. The group made note of domestic growth in line with their own forecasts, as well as robust global economic expansion and strong commodity prices. However, in terms of inflation, ‘upside risks’ was a phrase that was quickly being crowded out. Officials remarked that price pressures were below forecasts and they expected them to remain so over the next several months. The central bank attributed this quick deceleration in inflation to a high Canadian dollar that has curbed the countries competitiveness on the global market. What’s more, they suggested difficulties in the global financial markets would likely “persist for a longer time” and that under these circumstances both growth and inflation could cool.
BOC press releases on monetary policy changes can be found at http://www.bankofcanada.ca/en/monetary/target.html
RBNZ Governor Alan Bollard held adamant about keeping the official cash rate at 8.25 percent when he announced the rate bank’s rate decision on April 23rd. Despite the hawkish stance though, the policy authority did caution that a slowdown was inevitable, as economic growth had already deteriorated since their last meeting in March. Negative Building permits and house prices indicate that the economy is expected to worsen further, with little hope of an immediate recovery on the horizon. In fact in the past few months, data has shown that home growth in home values has cooled to its slowest pace on records going back two years and overall sales have dropped to a seven-year low. The more threatening component to the slowdown in growth has been the fading optimism surrounding the outlook for consumer spending. Though consumption gauges have been relatively steady in up to the most recent indicators, consumer confidence has tumbled to a 10-year low. In the past the Governor Bollard had plainly suggested that his primary concerns - outside of the inflation ring - for finally considering a policy stance change would be a distinct cooling in both consumer spending and the housing market boom. However, while the housing condition has been met, the consumer continues to threaten higher inflation down the line while encouraging confidence that positive growth could weather the uneven growth under the guidance of relatively wealthy New Zealanders.
What’s more, while the consumer stands as a strong influence for positive growth over the coming months and quarters, the RBNZ will no doubt find little reason not to concentrate on heady inflation trends – the primary driver for policy. Through the first quarter of this year, consumer prices rose at an annualized pace of 3.4 percent - the quickest rate of growth since the third quarter of 2006. With the benchmark inflation indicator well above the government’s mandated 2 to 3 percent inflation band, policy officials and economists see little option for easing the benchmark lending rate any time soon. Furthermore, with upstream pressures increasing under record food and energy prices, there is a considerable threat that price growth may reach the levels seen over the summer of 2006. On the other hand, this hawkish outlook does not come without its caveats. If the decade low in consumer sentiment levels translates into spending habits, businesses will likely respond by first firing employees and then lowering prices to fortify their bottom lines. Going forward, the RBNZ will have little scope to ease its policy stance until inflation is back within the group’s tolerance band or a deterioration in growth far outweighs the threat of rising prices.
RBNZ calendar of upcoming announcements can be found at http://www.rbnz.govt.nz/monpol/statements/0092224.html
Bank of Japan
On March 6th, officials from Bank of Japan came to the unanimous decision of keeping the target interest rates steady at 0.50 percent. This vote to keep policy steady has sustained a long period of neutrality as the last change to rates was back in February, 2007 when Governor Toshihiko Fukui announced the last 25 basis point hike. Although fears of a recession in the US, keep BoJ officials on their feet, the nine member board currently have their hands full with trying to deal with risks of inflation coupled with slowing economic growth. Recent inflation readings have shown that prices are increasing at the fastest pace in nine years, as producers continue to pass on higher raw material costs. In contrast, consumers continue to rein in spending with consumer confidence slumping to a five year low in January. This pessimism has been fueled by wages that have not kept up with living costs even though unemployment holds steady at multi-year lows. In comparison, recently released manufacturing data, tells a similar story as sentiments hit a 4 year low. These data paint a picture of an economy losing steam, and coincidently this ugly picture reminds investors of the US economy back in late 2007 as net investor cash flow into the economy is negative as Japanese investors direct their funds towards foreign economies in order to secure positive returns.
Considering the divergence between inflation and growth however, the Bank of Japan has few monetary policy options available to it should either factor demand action. If demand from Japan’s major trade partners falter, the economy will find little support from weak domestic demand and in turn cool the growth substantially. While inflation could be used as an argument for keeping rates steady, even if price growth were to head back to negative territory, the BoJ may not be able to respond. With the benchmark lending rate at a mere 0.50 percent, a rate cut would have little overall impact on economic activity as policy is already very accommodative and cannot afford much more adjustment. Another dynamic that could prevent the central bank from responding to either higher inflation or faltering growth is the reshuffling of the policy group’s ranks. Governor Toshihiko Fukui and his two deputies stepped down after long terms in March and debate has raged in Parliament as to suitable replacements who would be seen as independent from political influence. A new governor and deputies passed by a Parliament that is very predominately concerned with growth is not likely to raise rates, nor can they lower rates so close to the now familiar Zero Interest Rate Policy (ZIRP) level reigned a little more than a year ago.
BoJ calendar of monetary policy meetings can be found at http://www.boj.or.jp/en/theme/seisaku/kettei/index.htm