Central Bank Interest Rate Outlook
Written by Sonu Sadarangani, DailyFX Research
Highlights of Latest Policy Meetings:
In a statement released on April 27, 2011, the Federal Open Market Committee announced its decision to maintain its target interest rate between 0.00 and 0.25 percent, a level held unchanged since December 2008. The discount rate, at 0.75 percent, remains at a level below the 1 percent historical spread from the Fed Funds rate. According to information received from the Committee’s most recent meeting, the “economic recovery is proceeding at a moderate pace and overall conditions in the labor market are improving gradually.” The consumer price index rose 0.2 percent in May compared to a 0.4 percent increase in April, indicating a slowdown in inflation, a signal that traditionally spurs consumer spending. Although retail sales in May fell by 0.2 percent, the decline was lower than the 0.4 percent drop forecasted by economists, further providing signs of a gradually expanding economy. The Federal Reserve’s QE2 program to buy government bonds ends on June 30, 2011. Even though signals from the Fed do not indicate an extension of the program, officials have publicly announced that policy rates will be left unchanged in the event of no extension.
With interest rates expected to remain close to zero at least until the end of the year and the government bond buying program not likely to be extended, the Federal Reserve is left with very few monetary tools to stimulate the economy and growth. One option creating internal debate at the Fed is whether to raise the discount rate to 1.25 percent in order to maintain the historical one percentage point spread over the Fed Funds rate. Sentiment remains mixed over whether this action will create a stimulus. However, an increase in the discount rate will almost certainly be followed by an increase in the Fed Funds rate. The next rate decision meeting will be held on June 21, 2011 and “the Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.”
FOMC Statements and Calendar at: http://www.federalreserve.gov/FOMC/default.htm#calendars
European Central Bank
At its meeting on June 9, 2011, the Governing Council of the European Central Bank (ECB) decided to keep key ECB rates unchanged for the second month in a row, at 1.25 percent. In his introductory statement following the meeting, ECB President Trichet elaborated on the bank’s action to maintain 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. Overall, our monetary policy stance remains accommodative, lending support to economic activity.” The recent rise in energy and commodity prices have contributed to rising prices in the euro area, reflected in the 2.7 percent annual HICP inflation figure. With the ECB’s objective of keeping inflation below, but close to 2 percent in the medium term, Trichet addressed these inflationary concerns stating “strong vigilance is warranted. We will do all that is needed to prevent recent price developments giving rise to broad-based inflationary pressures.” This is largely indicative of an interest rate hike at the next meeting in July. 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.”
Economic and monetary analyses were the underlying determinants of maintaining the rate at 1.25 percent. Data revealed real GDP growth of 0.8 percent in the first quarter of 2011, quarter over quarter, a marked increase over the 0.3 percent 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.” Although expansion of the global economy should help the euro area, the Governing Council’s assessment of risks to the economic outlook states “activity is expected to continue to be dampened somewhat by the process of balance sheet adjustments in various sectors.” The June 2011 Eurosystem staff predicts an annual real GDP range of 1.5 percent to 2.3 percent for 2011 and a range of 0.6 percent to 2.8 percent for 2012.
Looking ahead, there is likely to be an interest rate hike at the next meeting in July as the ECB aims to reduce inflation below 2 percent. Aside from the monetary policy changes, Trichet emphasized the need for effective fiscal policies and structural reforms in the different eurozone 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. In particular, countries which have high fiscal and external deficits or which are suffering from a loss of competitiveness should rapidly carry out comprehensive economic reforms,” Trichet concluded.
ECB Statements can be found at: http://www.ecb.int
Bank of England
On June 9, 2011, the Bank of England’s Monetary Policy Committee voted to maintain the official Bank Rate paid on commercial bank reserves at 0.5 percent, leaving it unchanged for the 27th 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 percent 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. With the country facing an inflation rate of 4.5 percent, more than double its target of 2 percent, policy makers at the Bank of England agree that the economic outlook is not stable enough to withstand higher 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.”
According to the Office for National Statistics (ONS), GDP rose 0.5 percent in the first quarter of 2011. During the same time period, household spending fell by 0.6 percent in real terms. “Despite the fall in CPI inflation in March, the most likely near-term path of inflation was markedly higher than at the time of the February Inflation Report.” Although earlier reports showed that employment had picked up in the first quarter of 2011, a survey released on June 15 revealed jobless claims rose more than anticipated.
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 percent through the end of 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 June 7, 2011, the Board of the Reserve Bank of Australia decided to leave the cash rate unchanged at 4.75 percent. The rate has been maintained at this level since November, when it was increased from 4.5 percent, marking the longest period without a rate change in four years. The primary reason underlying the decision was an effort to spur economic recovery following the adverse weather conditions that have hurt the country’s economy in recent times. “The floods and cyclones over the summer have reduced output in some key sectors. As a result there was a sharp fall in real GDP in the first quarter of 2011, despite a solid increase in aggregate demand.” Employment growth in the first quarter has been gradual and has not significantly changed the unemployment rate which stands at 5 percent. CPI figures released for the first quarter showed an increase of 1.6 percent, more than anticipated and largely due to extreme weather conditions earlier in the year.
Looking ahead, “overall credit growth remains quite modest. Signs have continued to emerge of some greater willingness to lend, and business credit has expanded this year after a period of contraction.” There are signs that the beginning of an economic recovery is near as wage rates are at their highest levels since the downturn and the exchange rate is at its highest level in two decades. A rate hike seems imminent and may come in its next meeting which is scheduled for July 5, 2011. In future meetings, the Board will continue to assess carefully the evolving outlook for growth and inflation. Analysis indicates that inflation will likely rise in the short to medium term. In light of this, Governor Stevens of the RBA commented, “further tightening of monetary policy is likely to be required at some point for inflation to remain consistent with the 2-3 percent medium-term target.”
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 June 14, 2011, the Policy Board of the Bank of Japan unanimously voted to maintain the uncollateralized overnight night rate at 0.1 percent. The rate has been kept unchanged since December 2008 when it was cut 20 basis points. Despite some signs of an economic recovery, Japan continues to face downward pressure, mainly on the production side, largely due to the earthquake disaster. Hardest hit areas include production and exports and domestic private demand. Real exports have declined sharply since the earthquake. Supply side constraints caused exports to decline 6.9 percent in April on a month-on-month basis, following a steeper decline of 8 percent in March. Adding to worries that an economic recovery is not near was a drop of 0.9 percent of Real GDP in the first quarter of 2011, compared to a decline of 0.7 percent in the final quarter of 2010. The earthquake disaster has hurt the employment and income situation lending to a weak outlook for the unemployment rate. Japan’s unemployment rate increased slightly to 4.7 percent in April from 4.6 percent in March.
In the aftermath of the earthquake disaster, Japan is facing its second recession in three years as the economy shrank more than anticipated in the first quarter of 2011. Its focus looking forward will be on risks to growth, signaling that “it stands ready to ease monetary policy further if the earthquake’s damage proves bigger than expected.” In light of this and with no further easing appearing imminent, “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 July 12, 2011.
BOJ calendar of monetary policy meetings can be found at: http://www.boj.or.jp/en/mopo/index.htm/