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Central Bank Interest Rate Outlook February 2012

Central Bank Interest Rate Outlook February 2012

Tzu-Wen Chen, Technical Strategist

Central Bank Interest Rate Outlook

Central_Bank_Interest_Rate_Outlook_February_2012_body_x0000_i1025.png, Central Bank Interest Rate Outlook February 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: February 23, 2012

Central_Bank_Interest_Rate_Outlook_February_2012_body_Picture_8.png, Central Bank Interest Rate Outlook February 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 a 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 February 6, 2011, the Board of the Reserve Bank of Australia decided to leave its cash rate unchanged at 4.25 percent, after two consecutive rate cuts brought the benchmark rate down from 4.75 percent. The Board’s decision came as a surprise to many, as a 25 basis points rate cut had been widely anticipated. The Board’s decision was based on expectations that growth of the Australian economy would continue close to trend and inflation would converge close to target. This assessment was supported by recent data that suggested continuing moderate expansion in the U.S., robust, albeit moderated, growth in China, and recovery of commodity prices over the past couple of months.

The Australian economy continued to record moderate growth, with GDP estimated to have increased by around 2.75 percent over 2011, which is a little below average, partially reflecting the extreme weather events early in the year. Although labor market conditions softened during 2011, the unemployment rate remains low at around 5 percent. CPI inflation had declined as expected, as the large rises in food prices that resulted from the floods a year ago eased. The underlying inflation rate is around 2.5 percent, the midpoint of the medium-term target range, with year-ended CPI inflation expected to fall further over the next quarter or two.

RBA Interest Rates versus Expected Price Moves: February 23, 2012

Central_Bank_Interest_Rate_Outlook_February_2012_body_Picture_7.png, Central Bank Interest Rate Outlook February 2012

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

Looking forward, with growth expected to be close to trend and inflation close to target, the Board has judged that the current monetary policy will be appropriate in the near-term. The outlook for inflation is little changed from the forecasts published in the November Statement, with the Bank expecting inflation to be in the 2-3 percent range over the coming one or two years. Should demand conditions weaken materially, the inflation outlook would provide scope for easier monetary policy. The next rate decision meeting is scheduled for March 6, 2012.

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: February 23, 2012

Central_Bank_Interest_Rate_Outlook_February_2012_body_Picture_6.png, Central Bank Interest Rate Outlook February 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: February 23, 2012

Central_Bank_Interest_Rate_Outlook_February_2012_body_Picture_5.png, Central Bank Interest Rate Outlook February 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, 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 February 13, 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, while increasing the total size of its Asset Purchase Program by about 10 trillion yen, from about 55 trillion yen to 65 trillion yen, through the purchase of Japanese government bonds. The rate has remained unchanged since the last rate cut by 20 basis points in December 2008. The Bank’s decision for further monetary easing was based on better ensuring the economy’s return to a moderate recovery path and to overcome deflation and achieve sustainable growth with price stability amid “continued high uncertainty surrounding economic developments both at home and abroad”.

During the meeting, the Bank elaborated on its “price stability goal in the medium to long term” as a part of its efforts to further clarify its goals for overcoming deflation and achieving sustainable growth with price stability. The Bank defines this target inflation rate as a year-on-year rate of change in the consumer price index of 2 percent or lower and, more specifically, a goal of 1 percent for the time being.

Overall, Japan’s economic activity has been largely stagnant, mainly due to the effects of a slowdown in overseas economies and the appreciation of the yen. Exports and production have remained more or less flat, whereas domestic demand for business fixed investment has been on a moderate increasing trend and private consumption has remained firm, aided by restoration activities of earthquake-affected facilities. Housing investment has also been picking up and public investment has stopped declining.

BOJ Interest Rates versus Expected Price Moves: February 23, 2012

Central_Bank_Interest_Rate_Outlook_February_2012_body_Picture_4.png, Central Bank Interest Rate Outlook February 2012

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

Looking ahead, Japan’s economic activity is likely to remain flat for the time being. In additional to global uncertainties, Japan’s economy faces the long-term and structural challenge of a declining trend in growth rates amid rapid population aging. 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. On the price front, the year-on-year rate of change in consumer prices is currently around 0 percent, and is expected to remain at this level for the time being.

The Bank has re-affirmed its commitment to pursue powerful monetary easing through its virtually zero interest rate policy and Asset Purchase Program, as it aims to achieve its goal of a year-on-year rate of change in the CPI of 1 percent in the near-term. The next scheduled Monetary Policy Meeting will be held on March 13, 2012.

BOJ calendar of monetary policy meetings can be found at:

Bank of England

On February 9, 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 increase the size of its asset purchase program, financed by the issuance of central bank reserves, by £50 billion to a total of £325 billion. The bank rate has remained unchanged 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.

According to the Office for National Statistics (ONS), GDP fell by 0.2 percent in the fourth quarter of 2011, compared with a 0.6 percent gain in the prior quarter. 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. The underlying pace of economic recovery slowed slightly during the last quarter of 2011, with the U.K.’s main export markets slowing down amidst concerns about the indebtedness and competitiveness of some euro-area countries. With a weak outlook for new-term output growth, the Committee predicts that significant economic slack is likely to persist.

Despite CPI annual inflation falling to 4.2 percent in December from its September peak of 4.8 percent, inflation is still more than double its target of 2 percent. In the near term, inflation should continue to fall sharply, as the temporary impact of the increase in VAT in January 2011, and higher energy and import prices subside. Meanwhile downward pressure from unemployment and spare capacity continues to restrain domestically generated inflation.

Based on the weak near-term growth outlook and associated downward pressure from economic slack, the Committee voted to increase the size of its asset purchases, as it determined that inflation would very likely undershoot the 2 percent target in the medium term without further monetary stimulus.

BOE Interest Rates versus Expected Price Moves: February 23, 2012

Central_Bank_Interest_Rate_Outlook_February_2012_body_Picture_3.png, Central Bank Interest Rate Outlook February 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 on March 8, 2012.

BOE Statements can be found at:

European Central Bank

At its meeting on February 9, 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. This marks the second consecutive meeting decision to keep rates unchanged, after rate cuts of 25 basis points 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 that while there are some tentative signs of stabilization in economic activity, “the economic outlook remains subject to high uncertainty and downside risks. The underlying pace of monetary expansion remains subdued. Looking ahead, it is essential for monetary policy to maintain price stability for the euro area as a whole”.

Economic and monetary analyses were the underlying determinants of maintaining the rate at 1.00 percent. Monetary analysis revealed that the annual growth rate of M3 decreased to 1.6 percent in December, after 2.0 percent in November, reflecting a ‘further weakening of monetary dynamics towards the end of the year’. Draghi noted that “subdued global demand growth, the remaining tensions in euro area sovereign debt markets and their impact on credit conditions, as well as the process of balance sheet adjustment in the financial and non-financial sectors, continue to dampen the underlying growth momentum”.

With regards to price developments, Eurostat estimated that annual HICP inflation was 2.7 percent in January, unchanged from December, after reporting 3.0 percent in the preceding three months. Inflation rates have been elevated since the end of 2010, predominantly due to higher energy and commodity prices. The ECB expects that risks to the medium-term outlook for price development remain broadly balanced, with inflation likely to stay above 2 percent for several months to come, before declining to the central bank’s target of below 2 percent.

ECB Interest Rates versus Expected Price Moves: February 23, 2012

Central_Bank_Interest_Rate_Outlook_February_2012_body_Picture_2.png, Central Bank Interest Rate Outlook February 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 March as the ECB continues to strive towards maintaining price stability and reducing inflation below 2 percent in the medium term. It is worth noting that the ECB did not “discuss any prospective or current change in interest rates”, suggesting that the central bank has likely adopted a ‘wait-and-see’ approach as policy makers have observed that the Euro area economy stands to recover after a successful Greece debt deal.

In addition to discussing the monetary policy, Draghi emphasized the need for a combination of structural reforms and fiscal discipline, and for all countries to adhere to the fiscal targets they announced for 2012. Draghi concluded that the adherence to fiscal targets should “help to anchor expectations of sound fiscal policies and strengthen confidence”, while structural reforms are “key to increasing the adjustment capacity of euro area countries, thereby strengthening growth prospects and job creation.”

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: February 23, 2012

Central_Bank_Interest_Rate_Outlook_February_2012_body_Picture_1.png, Central Bank Interest Rate Outlook February 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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