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Central Bank Interest Rate Outlook - January 2012

Central Bank Interest Rate Outlook - January 2012

Tzu-Wen Chen, Technical Strategist

Central Bank Interest Rate Outlook

Central_Banks_Interest_Rate_Outlook_January_2012_body_Picture_1.png, Central Bank Interest Rate Outlook - January 2012

Written by Tzu-Wen Chen, DailyFX Research

Highlights of Latest Policy Meetings:

Federal Reserve

In a statement released on January 25, 2012, the Federal Open Market Committee announced its decision to leave the benchmark bank rate unchanged at 0.25 percent and maintain its target interest rate at 0 to 0.25 percent. The last rate change occurred in December 2008, when it was cut from 1.00 to 0.25 percent. FOMC’s statements revealed that the U.S. economy had been expanding at a moderate rate, despite some slowing in the growth of foreign economies and strains in global financial markets.

Household spending had continued to increase, while growth in business fixed investment had slowed and the housing sector remained depressed. Although indicators pointed to some improvements in labor conditions, the unemployment rate, at 8.5 percent in December, remained elevated. Inflation in recent months was subdued, and longer-term inflation expectations remained stable. In a statement of its long-term policy goals, the FOMC offered an official target for inflation of 2 percent, in contrast to previous indications that an inflation range of 1.7 to 2 percent was acceptable.

The Committee downgraded its outlook for U.S. economic growth for 2012, forecasting growth between 2.2 and 2.7 percent, down from November’s forecast of between 2.5 and 2.9 percent. However, the FOMC is slightly more optimistic about the labor market and expects unemployment to fall as low as 8.2 percent. The meeting concluded with the members continuing to see significant downside risk to the U.S. economy due to the ongoing global financial concerns.

FED Interest Rates versus Expected Price Moves: January 25, 2012

Central_Banks_Interest_Rate_Outlook_January_2012_body_Chart_2.png, Central Bank Interest Rate Outlook - January 2012

Chart created using data from Bloomberg – Prepared by Tzu-Wen Chen

Looking ahead, it is unlikely that the Federal Reserve will raise its target range for the federal funds rate until at least late 2014, extending its time frame by at least a year and half from the last decision meeting in December. Over the coming quarters, the FOMC expects to see a modest rate of economic growth and anticipates that inflation will run at levels at or below those consistent with the Committee’s dual mandate.

The FOMC expects to maintain a highly accommodative stance for monetary policy, in order to support a stronger economic recovery and to help ensure that inflation will converge to levels consistent with the dual mandate. The FOMC stated, “economic conditions – including low rates of resource utilization and a subdued outlook for inflation over the medium run – are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014”. Additionally, the Committee determined that it will continue its maturity extension program and reinvestment policy, as announced in September 2011.

FOMC Statements and Calendar can be found at:

Reserve Bank of Australia

At its meeting on December 6, 2011, the Board of the Reserve Bank of Australia decided to lower its cash rate by 25 basis points to 4.25 percent, the second consecutive rate cut that has brought the benchmark rate down from 4.75 percent. The primary reason underlying the decision was the threat of a slowdown to the nation’s commodity exports, as the sovereign credit and banking problems in Europe continue to weigh down on economic activity domestically and abroad. As financing conditions have become more difficult, the likelihood of a further material slowing in global growth has increased. Commodity prices have reflected this, falling over recent months and taking pressure off CPI inflation rates.

CPI inflation on a year-ended basis was above target, due to the effects of adverse weather conditions earlier in the year, though inflation has started to decline as production of key crops recovers. The unemployment rate has increased slightly since mid-year, though it remains low at around 5 percent. Domestically, overall growth was consistent with trend, and the expectation was that inflation would be consistent with the target over the next couple of years. Although this did not suggest a strong need to cut interest rates, the Board felt that there was scope for a modest cut to the cash rate as developments in Europe continued to pose downside risks to the global economy and, consequently, also to Australia.

RBA Interest Rates versus Expected Price Moves: January 25, 2012

Central_Banks_Interest_Rate_Outlook_January_2012_body_Chart_3.png, Central Bank Interest Rate Outlook - January 2012

Chart created using data from Bloomberg – Prepared by Tzu-Wen Chen

Looking forward, the forecast is for a further 25 basis points rate cut at the next rate decision meeting scheduled for February 7, 2012. While data for the U.S. economy had been better than in earlier months and growth rates in Asia remained solid despite some slowdown in trade, the European economy had been notably weaker and it remains unclear how the current situation would be resolved. Overall, the Board members concluded that the growth in the world economy is likely to weaken over the coming year.

RBA Statements on changes in monetary policy can be found at:

Reserve Bank of New Zealand

The Reserve Bank of New Zealand announced on January 25, 2012, its decision to leave the Official Cash Rate (OCR) at its record low level of 2.5 percent, unchanged since March. Reserve Bank Governor Alan Bollard said that although market sentiment had improved slightly since December’s review, “the global economy remains fragile and risks to the outlook remain”. While world prices for New Zealand’s export commodities remained elevated, the appreciation of the New Zealand dollar has undermined exporters’ returns. The continuing sovereign debt crisis in Europe has also escalated the cost of international funding, which in turn is likely to pressure funding costs for New Zealand banks over the next year.

Domestically, economic activity continued to expand, albeit at a modest pace, with some signs of limited recovery in household spending and in the housing market. Reconstruction works following the earthquake in Canterbury earlier in 2011 will also provide a significant boost to demand and economic growth. Reassuringly, inflation pressures had remained well contained, with inflation dropping to below 2 percent.

Bollard concluded, “Given ongoing uncertainty around global conditions and the moderate pace of domestic demand, it remains prudent to keep the OCR on hold at 2.5 percent.”

RBNZ Interest Rates versus Expected Price Moves: January 25, 2012

Central_Banks_Interest_Rate_Outlook_January_2012_body_Chart_4.png, Central Bank Interest Rate Outlook - January 2012

Chart created using data from Bloomberg – Prepared by Tzu-Wen Chen

Looking ahead, New Zealand’s monetary policy is likely to remain supportive of economic growth for the next few years. The N.Z. dollar was the best performer among G-10 currencies in December, as investors anticipated an economic rebound led by earthquake reconstruction activity. The RBNZ expects annual inflation to average about 2 percent in the next three years, which is within the 1 to 3 percent target range. Although Moody’s is forecasting rising economic growth and an increase in GDP by at least 2.5 percent in 2012, a weak global outlook combined with a need for a large reduction in the budget deficit will stem the pace of economic growth. Accordingly, Governor Alan Bollard signaled that the OCR may stay near the record-low 2.5 percent until mid-2012.

RBNZ calendar of upcoming announcements can be found at:

Swiss National Bank

At the Monetary Policy Assessment on December 15, 2011, the Swiss National Bank (SNB) announced its decision to maintain the target range for the Libor at 0.0-0.25 percent, and continues to aim for a three-month Libor close to zero. The SNB reaffirmed its commitment to the minimum exchange rate of CHF 1.20 per euro, based on concerns that an appreciated franc could threaten exports and growth. Since the introduction of the minimum exchange rate on September 6, 2011, the franc has depreciated more against the U.S. dollar than against the euro. However, at the time of the meeting, the franc was still high but should continue to weaken over time.

Growth in Europe in the third quarter remained weak and the economic outlook for the euro area continued to deteriorate. Against this backdrop, the pace of Swiss growth slowed significantly in the third quarter, with the substantial strengthening of the Swiss franc over the past summer weighing heavily on the economy. The SNB expects overall GDP growth in 2011 to come in between 1.5 and 2.0 percent, which is largely attributed to favorable economic development in the first half of the year. The SNB forecasts economic growth only in the order of 0.5 percent for 2012.

SNB Interest Rates versus Expected Price Moves: January 25, 2012

Central_Banks_Interest_Rate_Outlook_January_2012_body_Chart_5.png, Central Bank Interest Rate Outlook - January 2012

Chart created using data from Bloomberg – Prepared by Tzu-Wen Chen

Looking forward, with the resignation of Hildebrand as president in January, the SNB’s council is looking to announce a replacement in April or May, and continues to defend its 1.20 franc per euro exchange floor. In the short term, the SNB forecasts that inflation will dip into negative territory due to the appreciation of the franc in Q3 2011. In the longer term, the deteriorating growth outlook for the euro area is dampening inflation. Inflation rate forecasts for 2011 sit at 0.2 percent, while the SNB is expecting inflation of -0.3 percent for 2012 and 0.4 percent for 2013 based on the assumption of a three-month Libor of 0.0 percent over the next twelve quarters and a depreciating Swiss franc.

SNB Monetary Policy press releases can be found at:

Bank of Japan

At the Monetary Policy Meeting held on January 23, 2012, the Policy Board of the Bank of Japan unanimously voted to maintain the uncollateralized overnight call rate at around 0 to 0.1 percent. The rate has remained unchanged since the last rate cut by 20 basis points in December 2008. Overall, growth in Japan’s economic activity had stagnated and stimulative effects from the low rates had been somewhat constrained, largely due to the impact of slowdown in overseas economies and of the appreciating yen, as well as the remaining effects of the flooding in Thailand in October. Domestic demand for business fixed investments had been moderately increasing and private consumption had remained firm. Meanwhile, exports and production remained flat.

BOJ Interest Rates versus Expected Price Moves: January 25, 2012

Central_Banks_Interest_Rate_Outlook_January_2012_body_Chart_6.png, Central Bank Interest Rate Outlook - January 2012

Chart created using data from Bloomberg – Prepared by Tzu-Wen Chen

Looking ahead, Japan’s economic activity is likely to remain flat. The Bank cut its growth outlook, lowering its economic forecast for 2012 to 2 percent from and October estimate of 2.2 percent. Nonetheless, growth prospects for fiscal 2012 and 2013 will “likely remain broadly unchanged because the economy is expected to gradually return to a moderate recovery path in the first half of fiscal 2012”. Moderate recovery in Japan is expected as the recovery of overseas economies starts to gain pace, led by emerging and commodity-exporting economies, and a pickup in earthquake-reconstruction activities. Likewise, exports and production are expected to remain flat and increase moderately as recovery in overseas economies gain pace.

The year-on-year rate of change in CPI is currently around 0 percent and is expected to remain around this level for the time being. Meanwhile, the sovereign debt problem in Europe continues to pose significant downside risks to overseas economies and international commodity prices, which may impact further on Japan’s growth and medium-to-long-term inflation expectations.

The Bank has continued with its monetary easing measures through its Asset Purchase Program, and affirmed its commitment to maintaining interest rates around near-zero levels until “it judges that price stability is in sight on the basis of understanding of medium-to-long-term price stability”. The next scheduled Monetary Policy Meeting will be held on February 14, 2012.

BOJ calendar of monetary policy meetings can be found at:

Bank of England

On January 12, 2012, the Bank of England’s Monetary Policy Committee voted to maintain the official Bank Rate paid on commercial bank reserves at 0.5 percent. The Committee also voted to continue with its program of asset purchases financed by the issuance of central bank reserves totaling £275 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, with the last change, an increase of £75 billion, taking place on October 6, 2011.

Despite CPI annual inflation falling to 4.2 percent in December from 4.8 percent, inflation is still more than double its target of 2 percent. The high inflation levels largely result from the temporary impact of the increase in standard rate of VAT in January 2011, and higher energy and import prices. Inflation in the first part of 2012 is expected to fall sharply as the effects of these temporary factors subside. However, there is less certainty in the speed and extent of the fall in inflation thereafter. Although CPI inflation had been falling in line with the Committee’s expectations, there is a risk that elevated inflation could be more persistent than expected due to further upward external price shocks or due to a stronger contribution from firms’ margins or unit labor costs.

According to the Office for National Statistics (ONS), GDP rose by 0.6 percent in the third quarter of 2011, exceeding the median forecast of 0.5%. Meanwhile, the unemployment rate had risen to 8.4 percent in the fourth quarter of 2011, and is expected to increase further over the next few months.

Overall, the Committee concluded that substantial risks to UK activity and inflation remain in both directions. While near-term inflation risks appeared to have moderated, there was little change to the balance of risks in the medium term. Accordingly, the Committee determined that a policy change was not warranted, though it was noted that further expansion of the asset purchase programme may become warranted in due course. However, there was no compelling need to increase the scale of the programme before completing those already announced.

BOE Interest Rates versus Expected Price Moves: January 25, 2012

Central_Banks_Interest_Rate_Outlook_January_2012_body_Chart_7.png, Central Bank Interest Rate Outlook - January 2012

Chart created using data from Bloomberg – Prepared by Tzu-Wen Chen

Looking forward, it is clear that the Bank of England’s MPC is focused on economic growth in conjunction with 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 at the next meeting in February.

BOE Statements can be found at:

European Central Bank

At its meeting on January 12, 2012, the Governing Council of the European Central Bank (ECB) decided to maintain the interest rates on the main refinancing operations, marginal lending facility and deposit facility unchanged at 1.00 percent, 1.75 percent and 0.25 percent respectively, following the 25 basis points decreases in November and December 2011. In his introductory statement following the meeting, ECB President Mario Draghi elaborated on the bank’s action to maintain the key rate level stating “the underlying pace of monetary expansion remains moderate. The economic outlook remains subject to high uncertainty and substantial downside risks. Overall, it is essential for monetary policy to maintain price stability over the medium term”.

Economic and monetary analyses were the underlying determinants of maintaining the rate at 1.00 percent. Real GDP in the euro area grew by 0.1 percent quarter-on-quarter in the third quarter of 2011, slowing down from the 0.2 percent growth in the second quarter. Factors dampening the underlying growth momentum in the euro area include moderate global demand growth and weak business and consumer confidence in the euro area. Domestic demand is likely to be dampened by the ongoing tensions associated with the sovereign debt markets, as well as the process of balance sheet adjustment in the financial and non-financial sectors. Nonetheless, the ECB is expecting euro area economic activity to recover, albeit very gradually, through 2012.

Inflation is likely to stay above 2 percent for several months to come before declining to below 2 percent. With the ECB’s objective of keeping inflation below, but close to, 2 percent in the medium term, Draghi addressed these inflation concerns stating that firm anchoring of inflation “is a prerequisite for monetary policy to make its contribution towards supporting economic growth and job creation in the euro area.” With regards to price developments, annual HICP inflation was 2.8% in December 2011, after 3.0% in the preceding three months. This drop was expected, as inflation rates had been elevated since the end of 2010, predominantly due to higher energy and commodity prices.

ECB Interest Rates versus Expected Price Moves: January 25, 2012

Central_Banks_Interest_Rate_Outlook_January_2012_body_Chart_8.png, Central Bank Interest Rate Outlook - January 2012

Chart created using data from Bloomberg – Prepared by Tzu-Wen Chen

Looking ahead, there is unlikely to be an interest rate change at the next meeting in February as the ECB continues to strive towards reducing inflation below 2 percent. In addition to discussing the monetary policy, Draghi emphasized the need for euro area government support of recent fiscal policy changes and called for the urgent implementation of “bold and ambitious” structural reforms. Draghi concluded, “Going hand in hand, fiscal consolidation and structural reforms would strengthen confidence, growth prospects and job creation. Key reforms should be rapidly carried out to help the euro area countries to improve competitiveness, increase the flexibility of their economies and enhance their longer-term growth potential.”

ECB Statements can be found at:

Bank of Canada

At its January 17, 2012 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. The target overnight rate has remained unchanged since September 2010, after seeing three consecutive 25 basis points hikes from 0.25 percent. Since the release of the Bank’s October Monetary Policy Report (MPR), the outlook for the global economy has deteriorated and uncertainty has increased as the sovereign debt crisis in Europe continued to intensify. Although the recession in Europe is now expected to be deeper and longer than was anticipated in October, the Bank continues to assume that European authorities will implement sufficient measures to contain the crisis whilst acknowledging the downside risks to this assumption.

The Canadian economy is estimated to have grown by 2.4 percent in 2011, and is projected to grow by 2.0 percent in 2012 and 2.8 percent in 2013, returning to full capacity by the third quarter of 2013. Total CPI inflation is expected to return to the 2.0 percent target by the third quarter of 2013.

BOC Interest Rates versus Expected Price Moves: January 25, 2012

Central_Banks_Interest_Rate_Outlook_January_2012_body_Chart_9.png, Central Bank Interest Rate Outlook - January 2012

Chart created using data from Bloomberg – Prepared by Tzu-Wen Chen

Looking forward, the Bank’s overall outlook for the Canadian economy remains largely unchanged from the October MPR. While there was more momentum than anticipated in the second half of 2011, the pace of growth going forward is expected to be more modest than previously envisaged, largely due to ongoing household deleveraging, fiscal consolidation, and the global environment. Both total and core inflation are projected to moderate in 2012, falling temporarily below 2 percent and subsequently converging to 2 percent by the third quarter of 2013 as “excess supply is gradually absorbed, labor compensation grows modestly and inflation expectations remain well-anchored”. Net exports are expected to contribute little to growth, reflecting moderate foreign demand and ongoing competitiveness challenges, including the persistent strength of the Canadian dollar. Conversely, favorable financing conditions are expected to boost consumer spending and housing activity, with household expenditures expected to remain high relative to GDP.

With the target interest rate near historic lows and the financial system functioning well, there is “considerable monetary policy stimulus in Canada”. The Bank will continue to monitor economic developments and set monetary policy “consistent with achieving the 2 per cent inflation target over the medium term”. At this stage, a change in the interest rate at the next meeting in March seems unlikely.

BOC press releases on monetary policy:

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