Central Bank Watch
By John Kicklighter, Currency Strategist and DailyFX Research Team Highlights of Latest Policy Meetings: Federal Reserve On April 29, 2009, the Federal Reserve voted unanimously to maintain its overnight lending rate at 0.25 percent. The decision to hold comes as little surprise since the benchmark has been deflated to such unprecedented low levels. Despite the extraordinary level of easing, inflationary pressures that usually come with such a move have remained subdued. In fact, inflation has remained so low that the Fed has expressed some level of concern over deflationary risks. On the economic front, there may be some level of support for why this may be the case. True, some releases show a decline in the rate of contraction in several key areas of the economy, but upon closer inspection, these releases show little to make one bullish. While a recent Non-Farm Payrolls release shows a drastic deceleration in job losses, falling only 325,000 from a prior 525,000, the amount lost is still indicative of significant contraction. Meanwhile, other indicators of economic activity show further deterioration is in store for the economy. Consumer spending fell as retail sales declined along with Income. On the financial front, institutions still harbor risk through the near-term. Many remain exposed to a number of financial instruments that present greater likelihood of losses in an extended recession. This is troubling given that 10 out of the 19 major banks failed the US Treasury Stress Test and need to raise further capital. Further worrisome is another separate report from the Federal Depository Insurance Corporation, showing a jump of 54 new “problem” banks this quarter, now totaling 304. Given these circumstances, the Federal Reserve may have yet to expand its operations with further quantitative easing. In this regard, the Fed’s balance sheet may be limited in how much further it can expand such programs. Concern is rising over how many more risky securities the central bank can take onto its balance sheet. As such, focus is beginning to home in on the Fed’s exit strategy. Even if not entirely reflective of current weakness, the minor signs of economic improvement sparked discussion over this important issue. With the sheer size of holdings, selling pressure that would result from unloading its balance sheet could depress securities markets, damaging existing holdings at banks. On the other hand, with such large capital injections, a recovery could trigger dormant inflationary risks in the system. As it stands, the crisis intervention efforts from the Fed, The US Treasury, and Congress compound this problem greatly. In turn if further signs of improvement emerge, the Federal Reserve will have to begin addressing these concerns. On the one hand, if the Fed fails to acknowledge these long-term effects and outline how they will begin to approach in dealing with them, the financial markets could suffer from a confidence crisis and possibly lead to more credit woes. On the other hand, if left unaddressed, runaway inflation could very quickly erode a healthy recovery and possibly lead to a condition of stagflation. Regardless, a recovery must establish itself first. Until then, the Fed will likely keep focus on how best to promote the economy. Given current conditions, the most likely result will be further expansion of its quantitative easing programs. FOMC Statements and Calendar at http://www.federalreserve.gov/FOMC/default.htm#calendars European Central Bank On May 5, 2009, the European Central Bank announced that it would reduce both the main refinancing rate as well as the marginal lending facility rate by twenty-five and fifty basis points respectively. This brings the new rates to record lows of 1.0 percent and 1.75 percent. While extraordinary, the move did fall in line with economists’ predictions following data that showed further acceleration in the European economy recession. In his address following the decision, President Jean-Claude Trichet stated that ECB analysis showed strong evidence that the economic and financial condition of the Euro zone weakened more than expected in the first quarter. While accepting that some more recent economic releases hinted at stabilization, he immediately offered a disclaimer, stating that they remained at very low levels with only modestly better results. One such release was the Manufacturing Purchasing Managers Index, which showed slightly better than forecast results and helped raise optimism. Reflecting the modest uptick in sentiment, the ZEW survey reported a rise from -6.5 to 11.8. Perhaps the biggest ray of light since comes from the 3-month Libor, which by May 16, 2009 declined to 0.79 bps, the lowest level on record since as far back as 1990. The Libor’s current level is supportive of the notion that a bottom may be forming. The thawing of lending markets is after all one of the necessary ingredients to kick starting credit and turning the economy out of its recession. On the other hand, while there were highlights, most economic data argues strongly toward the downside. Consumers reeling from rising unemployment at 8.5 percent and rising continue to tighten their spending. Retail Sales fell as much as 4.2 percent for the year. Clearly neither consumers nor
Nonetheless, given the recent level of the Libor, ECB interventions may no longer be necessary, as this was one of the key targets of the bank’s actions. If the downturn shows signs of weakening one can expect that the board is still ready and willing to pursue further aggressive action. Some comments from the Q&A after the decision point to this reality. For example, asked about purchases of covered bonds and whether the ECB was open to purchase of other asset-types, Jean-Claude Trichet gave very vague and non-committing answers. Evidently, the president wishes to neither rule out the possibility, nor accept it quite yet. The ECB’s pace for monetary policy will of course hinge upon further performance of the economy in the coming month. In this regard, expectations for near-term growth remain dim. The governing council forecasts that economic activity will stay muted for the remainder of the year. Accordingly, they expect that the a true recovery will not begin until 2010. In the meantime, the recession combined with lower commodity prices has offset inflation, dampening the need to respond to to a rapid rebound in prices. Nonetheless, with a turnaround in sight, the ECB’s interventions of the past two years present substantial inflationary risks for the long-term. Looking further in to the future, the ECB’s ‘exit strategy’ may now be even more important for future stability than its current actions. Given the delicate balance necessary for stability, the board finds itself stuck between the long-term and short-term impact of its actions. As policy rates are closing in on 0 percent, the ECB will have to consider other unprecedented actions in order to boost liquidity. In this regard, if the recession grows steeper, market participants have to speculate on the current race of pace cuts that the ECB is more willing to pursue unorthodox actions. This could mean quantitative easing in the near future. ECB news releases can be found at:
Bank of England The Bank of England’s Monetary Policy Committee’s May 7th meeting resulted in a vote to maintain the official Bank Rate at 0.50%. The MPC also voted to increase the size of its Asset Purchase Programme by £50 billion, to a total of £125 billion. According to the official statement that accompanied the release, the decision to hold the benchmark interest rate was borne primarily from the desire to avoid a sudden rebound in inflation. In its March statement, the MPC made clear the notion that “a very low level of Bank rate could have counter-productive effects on the operation of some financial markets and on the lending capacity of the banking system.” CPI inflation was 2.9 percent in March, higher than the 2.0 percent target set by the BoE. However, it is more likely a desire to avoid the stigma associated with a zero interest rate policy. Significant economic stimulus resulting from the easing of monetary and fiscal policy, a depreciating Pound, and relatively low commodity prices has helped improve the availability of credit. Policymakers determined that the stimulus should lead to a recovery in economic growth. Going into the meeting, policymakers were facing a downtrodden economy dragged down by contracting output and rising unemployment. Industrial production in February contracted 12.5% on a year-over-year basis following twelve consecutive monthly declines. PMI Manufacturing for April was 42.9, marking a full-year of contraction the sector. Pointing to further weakness ahead, the National Institute of Economic and Social Research expects the UK economy to contract 1.5% in Q1 following two consecutive quarters of decline. Jobless claims increased by 73.7 thousand in March, and the seasonal average for unemployment in February was 6.7 percent. The outlook, though, leans positive as surveys in England and across the major world economies show that the pace of decline has begun to moderate. Data from the housing market has taken an encouraging glean recently with 39 thousand mortgage applications being filed in March, recovering from a record low 27 thousand applications in January, and home prices dropping 1.7 percent, suggesting that the housing market may be forming a bottom. Some observers, though, remain pessimistic about the direction of the UK economy. In its recent World Economic Report, the IMF revised its projection for the UK economy to contract 2.8% this year, a significant change from its earlier forecast for a contraction of 1.3%. The revision came after the group raised its forecast for global losses tallied through the financial crisis to reach $4.1 trillion. Losses in the UK are expected to rise an additional $200 billion over the next two years with lenders needing “a further $125 billion in capital to restore their balance sheets to the state they were in before the crisis.” Looking ahead, the £125 billion Asset Purchase Programme is expected to continue for another three months; and the MPC will keep the scale of the program under review. Next meeting, the BoE is unlikely to change rates, and instead rely on quantitative easing, as the policy authority struggles to stabilize the economy and plug the financial hemorrhaging. BOE Statements can be found at: http://www.bankofengland.co.uk/monetarypolicy/decisions.htm Swiss National Bank The Swiss National Bank continued its easing regime at its quarterly meeting on March 12, 2009. While maintaining the range of 0.0 percent to 0.75, they moved their target lower to 0.25 percent. This is a level unseen in over ten years. Following the rate reduction were announcements of further repo operations, currency intervention and purchases of private bonds. These actions should increase liquidity in response to the unremitting appreciation of the Swiss Franc. The SNB has thus made moves that reflect expectations for an outsized slowdown in its economy. Their outlook is understandable if considering a number of economic reports that preceded the decision. Exports contracted sharply in December, declining over 13.3 percent with only a modest gain of 6.7 percent in January. Imports also showed weakness with a 5 percent decline in December and a meager 0.8 percent bounce in January. Unemployment rose 3.3 percent in January, worse than expected. Prices meanwhile remain stagnant. The Consumer Price Index in February rose only 0.2 percent, raising concern over possible deflationary pressures. Furthermore, Producer and Import prices fell 0.8 percent in January. Consumers reeling from rising unemployment have led to weakened sentiment as can be seen by the SECO Consumer Climate report, which continues to show a negative reading. Echoing sentiment born from the data, the SNB has revised expectations for Real Gross Domestic Product to decline over 2.5 to 3 percent in 2009 – which though pessimistic, still places the Swiss economy in a better position than most of its trade counterparts. Even though the economic docket has not shown weakness on par with major trade partners, the SNB’s rate reduction is in line with other central banks in the US, the UK, and Japan. However, in the policy decision commentary, the committee has made clear that their measures aim to reverse an overly inflated currency. This would in effect help curtail two main risks to the economy. One being to offset deflationary pressures that have begun to surface due to economic slowdown coupled with the stronger currency. The other risk that would be offset would be the negative impact that the strong currency has on exports. Data following the decision has already begun to suggest weight to this prognosis as several releases show increasing weakness and growing deflationary risks. The SNB’s recent measures will take time to be reflected in the economic docket and it remains to be seen how quickly their actions will take effect or how effective they will be. Nevertheless, if the Swiss Franc does not pull back, the policy committee has made it very clear they are ready to continue actions that would provide further liquidity. The SNB’s moves seem to contradict statements released from the recent G-20 meeting in which they warned against protectionist policies that could result from the crisis. Some trade partners such as the Euro-zone have already expressed concern with the SNB’s actions in distorting the currency markets as the Swiss Franc is viewed as a tax haven. Since the G-20 is responsible for 85% of export activity, the Swiss will have to abide by these requests or risk other consequences to their economy. In the mean time, since the LIBOR has very little room to move any further, the SNB will have to continue down a path of more unorthodox monetary policy to achieve its goals. The SNB has so far not pursued quantitative easing but given recent commentary, it seems the committee is open to further unconventional actions at their next quarterly meeting. So long as negative pressures remain on the economy, the SNB will likely remain focused toward ongoing easing or perhaps pursue a more unorthodox approach. SNB Monetary Policy press releases can be found at http://www.snb.ch/e/aktuelles/ Reserve Bank of Australia On June 2, 2009, the Reserve Bank of Australia held its benchmark rate at three percent for the second time as the policy board returns to its wait-and-see approach to recovery. The central bank has lowered the cash rate target 425 basis points from a high of 7.25% last March as economic activity decelerates and inflation evaporates. However, monetary easing, in conjunction to a A$42 billion fiscal stimulus, has started to spur growth in the nation. Australia avoided its first recession since 1991 as GDP expanded at a 0.4% pace in the first quarter following a 0.6% contraction in the fourth. As well as improvements domestically, resurgence in exports has helped support recovery. Citing evidence “that the global economy is stabilising,” the statement issued by Governor Glenn Stevens discusses a clear turnaround “in China and some other emerging countries.” Also hinting at optimism is a remark that loan rates may still drop further and support expansion in the housing sector and credit markets. The economy is showing improvement with building approvals on the rise in the past three months while retail sales grew slightly at 0.3% in April. Indicators including business confidence and conditions remain well off their lows while employment actually rose in May by more than 27,000 jobs. Aside from improvements domestically, global conditions, vital to Australia’s heavily trade dependent economy, have improved with China’s manufacturing sector expanding for the third month. The Baltic Dry Index, which measures trade and shipping prices for commodities, adds further evidence to recovery as the figure has rallied significantly off its lows to an eight month high. Signs of growth are chiefly responsible for inaction in the policy board meeting. The RBA statement left the door open to further rate cuts dependent on inflation. CPI data has cooled steeply since peaking at five percent in 2008Q3 and stood at 2.5% in the first quarter. More timely, the TD Securities’ inflation index cooled to a 1.5% pace in May from 2.1% in April. Also adding to the RBA’s concerns is financial stability. Difficulty in the housing sector and rising unemployment could lead to considerable losses for Australia’s financial firms. The nation’s major banks have had minimal exposure to the financial crisis and posted full year profit that did not drop significantly. Despite this, the banks may limit lending as losses mount from higher unemployment and delinquencies. A new round of rate cuts may occur in the quarters ahead as the policy board has considerable room to maneuver with further monetary easing to tackle lower inflation and economic weakness. RBA Statements on changes in monetary policy can be found at http://www.rba.gov.au/ Bank of Canada On April 21, 2009, the Bank of Canada surprised markets with yet another rate reduction, bringing the overnight lending rate 25 bps lower to 0.25 percent. While the cut was unexpected by economists, a closer analysis of economic data that preceded the decision supports the move for further easing. A slew of reports suggest that the economy is indeed contracting at a much faster pace than originally predicted. GDP fell over 0.7 percent in January. A more timely release, the Ivey Purchasing Managers index, showed a much sharper contraction than predicted, declining to -43.2. Business Outlook for future sales also echoed this outlook, remaining pessimistic at -22. Meanwhile, the economic slowdown has hit businesses, leading many to cut jobs raising the unemployment rate to 8.0 percent. As a result, consumers have begun to tighten their spending. Evidence of pullback comes from a 2.2 percent decline in new vehicle sales along with declines in house prices by 0.7 percent. Consequently, the contraction in the economy coupled with lower energy costs held price pressures at a paltry 1.2 percent for the year. Since the data, global contraction has sped up even further while inflation remains well under target. Given the circumstances, the decision for further easing seems to be the most suitable course of action. In total, the latest cut shows a total of 425 bps worth of easing since December 2007, a substantial amount of liquidity pumped into the system. Time will tell how effective the reductions will be, but if the comments from the latest monetary policy report are any indication, the Canadian economy is in line for further weakness. The report extended expectations for a pronounced contraction to continue well into the third to fourth quarter of 2009. Furthermore, the board does not expect a recovery to begin until the second quarter of 2010. As a result, inflation projections from the bank anticipate that prices will stay below the 2.0 percent target until well into 2011. With an overnight rate approaching 0 percent, the board is running out of traditional methods to boost liquidity. They may soon begin pursuing similar unorthodox measures as some other major Central Banks as in the US , the UK, and Switzerland. The US Federal Reserve and the Bank of England have both pursued unprecedented market intervention in order to combat the severity of the downturn. Some methods they have employed are purchases of corporate bonds on the open market, quantitative easing, and some (as in Switzerland’s case) currency interventions. Given the level of projected weakness for the Canadian economy, these methods may be the next step at the board’s next meeting. BOC press releases on monetary policy changes can be found at http://www.bankofcanada.ca/en/monetary/target.html Reserve Bank of New Zealand 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