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Central Bank Interest Rate Outlook March 2012

Central Bank Interest Rate Outlook March 2012

Tzu-Wen Chen, Technical Strategist

Central Bank Interest Rate Outlook

Central_Bank_Interest_Rate_Outlook_March_2012_body_Picture_9.png, Central Bank Interest Rate Outlook March 2012

Written by Tzu-Wen Chen, DailyFX Research

Highlights of Latest Policy Meetings:

Federal Reserve

In a statement released on March 13, 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 moderately since the FOMC’s last monetary policy meeting in January.

On the upside, household spending and business fixed investment had continued to advance, while labor market conditions had improved further. However, despite notable declines in recent months, the unemployment rate, at 8.3 percent in February, remains elevated. On the downside, the housing sector remains depressed, as it continues to struggle with foreclosures, lower house prices and slow demand. Inflation has been subdued in recent months despite increases in crude oil and gasoline prices, and longer-term inflation expectations remained stable.

The Committee reiterated its commitment to foster maximum employment and price stability, in line with its statutory mandate. Although the recent increase in oil and gasoline prices will drive up inflation temporarily, the Committee anticipates that inflation will subsequently run at or below the rate that ‘it judges most consistent with its dual mandate’. In the FOMC’s January statement of long-term policy goals, the Committee offered an official target for inflation of 2 percent, in contrast to previous indications that an inflation range of 1.7 to 2.0 percent was acceptable. Meanwhile, the Committee expects moderate economic growth over coming quarters, and consequently anticipates a gradual decline in the unemployment rate towards levels consistent with its dual mandate. Although strains in the global financial markets have eased, the Committee noted that they continue to pose significant downside risks to the economic outlook.

FED Interest Rates versus Expected Price Moves: March 30, 2012

Central_Bank_Interest_Rate_Outlook_March_2012_body_Picture_8.png, Central Bank Interest Rate Outlook March 2012

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

Looking ahead, the Federal Reserve reiterated that it is unlikely to raise its target range for the federal funds rate until at least late 2014. 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. The next monetary policy decision meeting is scheduled for April 25, 2012.

FOMC Statements and Calendar can be found at:

Reserve Bank of Australia

At its meeting on March 5, 2011, the Board of the Reserve Bank of Australia decided to leave its cash rate unchanged at 4.25 percent. The cash rate has been unchanged since December 2011 after two consecutive rate cuts brought the benchmark rate down from 4.75 percent. The Board’s decision was based on expectations that growth of the Australian economy would continue close to trend and inflation close to target. This assessment was supported by recent data suggesting continuing moderate expansion of the U.S. economy, robust, albeit moderated, growth in China, and the recovery of commodity prices over the past couple of months.

Data on the Australian economy continues to suggest growth close to trend overall. Labor market conditions had softened during 2011 and although the unemployment had increased slightly mid-year, it has remained steady at around 5.2 percent over recent months. CPI inflation had declined as expected and is anticipated to decline further over the next quarter or two. The underlying inflation rate is around 2.5 percent.

RBA Interest Rates versus Expected Price Moves: March 30, 2012

Central_Bank_Interest_Rate_Outlook_March_2012_body_Picture_7.png, Central Bank Interest Rate Outlook March 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 February Statement, with the Bank expecting inflation to be in the 2-3 percent range over the coming one or two years. The Board noted that the ‘clearest downside risk to the outlook for Australia remained a sudden worsening in the situation in Europe and its flow-on effects to the rest of the world through trade, financial and confidence channels’. Should demand conditions weaken materially, the inflation outlook would provide scope for easier monetary policy. The next rate decision meeting is scheduled for April 3, 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 March 7, 2012, its decision to leave the Official Cash Rate (OCR) at its record low level of 2.5 percent, unchanged since March 2011. Reserve Bank Governor Alan Bollard said that ‘inflation has settled near the middle of the Bank’s target range, and inflation expectations have fallen’. Annual headline inflation is estimated to have returned within the RBNZ’s 1 to 3 percent target band in the December quarter, while underlying inflation continues to sit close to 2 percent.

Domestically, economic activity had been showing signs of recovery, with a pick-up in household spending and building activity over the past few months. Recovery of the building sector is expected to strengthen as repairs and reconstruction work following the earthquake in Canterbury in 2011 pick up later in the year. High export commodity prices have also boosted domestic economic recovery, though the appreciation of the New Zealand dollar has undermined exporters returns. Bollard noted ‘while helping contain inflation, the high value of the New Zealand dollar is detrimental to the tradable sector, undermines GDP growth and inhibits rebalancing in the New Zealand economy. Sustained strength in the New Zealand dollar would reduce the need for future increases in the OCR.’

Although policy actions from other central banks have boosted global confidence, market sentiment remains fragile and risks to the global outlook remain. Bollard concluded, “Given the medium-term outlook for inflation, it remains prudent to keep the OCR on hold at 2.5 percent.”

RBNZ Interest Rates versus Expected Price Moves: March 30, 2012

Central_Bank_Interest_Rate_Outlook_March_2012_body_Picture_6.png, Central Bank Interest Rate Outlook March 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 in the medium term. In the March Statement, the Bank noted that ‘market pricing suggests that the first full OCR increase is not expected to occur until early 2013’. Assuming that the New Zealand dollar depreciates modestly over the next few years, the Bank anticipates that the pace of GDP growth will pick up on the back of increased construction sector activity and eliminate current spare capacity over the coming year. This is likely to cause underlying inflationary pressure to pick up from its current subdued level. Conversely, sustained high valuation of the New Zealand dollar will place further downward pressure on inflation, lowering the outlook for the OCR relative to the RBNZ’s December projection. The next monetary policy decision meeting is scheduled for April 25, 2012.

RBNZ calendar of upcoming announcements can be found at:

Swiss National Bank

At the Monetary Policy Assessment on March 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, and announced that it is prepared to buy foreign currency in unlimited quantities for this purpose. The SNB will continue to maintain liquidity on the money market at an exceptionally high level.

Global economic developments have been mixed, with the U.S. economy showing positive growth while GDP fell in the euro area and Japan. Against this backdrop, the pace of Swiss growth slowed significantly over the course of the past year, though there are growing indications that the Swiss economy is stabilizing. Although the elevated value of the Swiss franc continues to pose significant economic challenges, the minimum exchange rate has been effective in reducing exchange rate volatility. The SNB is now forecasting moderate growth at close to 1 percent through 2012, an upward revision from its December forecast of around 0.5 percent.

SNB Interest Rates versus Expected Price Moves: March 30, 2012

Central_Bank_Interest_Rate_Outlook_March_2012_body_Picture_5.png, Central Bank Interest Rate Outlook March 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. The SNB’s inflation forecast, which is based on the assumption of a three-month Libor of 0.0 percent, has been adjusted downwards from that of December and there is no risk of inflation in the foreseeable future. In the short term, inflation will move further into negative territory. In the longer term, inflation will be lowered if the growth outlook for the euro area worsens and if high valuation of the Swiss franc persists. The SNB is now forecasting an inflation rate of -0.6 percent for 2012, 0.3 percent for 2013 and 0.6 percent for 2014. The next monetary policy decision meeting is scheduled for June 14, 2012.

SNB Monetary Policy press releases can be found at:

Bank of Japan

At the Monetary Policy Meeting held on March 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. The rate has remained unchanged since the last rate cut by 20 basis points in December 2008. The Board also voted against increasing the size of its Asset Purchase Program, maintaining the total volume of the program at around 65 trillion yen which has been unchanged since the last injection of monetary easing by 10 trillion yen in February 2012.

During the meeting, the Bank decided to enhance the fund-provisioning measure to support strengthening the foundations for economic growth, or “Growth-Supporting Funding Facility”, determining that the total amount of loans available through the Growth-Supporting Funding Facility will increase by 2 trillion yen, from 3.5 trillion yen to 5.5 trillion yen.

Overall, Japan’s economic activity has been largely stagnant, though it has shown some signs that it is picking up. Domestically, business fixed investment has been on a moderate increasing trend, aided by restoration activities of earthquake-affected facilities, and private consumption has firmed. Conversely, exports and production have remained more or less flat, mainly due to the effects of the slowdown in overseas economies and the appreciation of the yen.

BOJ Interest Rates versus Expected Price Moves: March 30, 2012

Central_Bank_Interest_Rate_Outlook_March_2012_body_Picture_4.png, Central Bank Interest Rate Outlook March 2012

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

Looking ahead, Japan’s economy is expected to gradually emerge from the current phase of flat growth and return to a moderate recovery path as the recovery of overseas economies gains pace, led by emerging and commodity-exporting economies, and a pickup in earthquake-reconstruction activities. Preliminary indicators are pointing to a possible pick-up in production and public investment in the coming period.

On the price front, the year-on-year rate of change in the CPI is around 0 percent and is expected to remain around this level for the time being. The Bank defines the target inflation rate consistent with medium-to-long term price stability as a year-on-year rate of change in the CPI of 2 percent or lower and, more specifically, a goal of 1 percent 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. At the same time, the Bank will strive towards promoting Japan’s economic growth through the Growth-Supporting Funding Facility. The next scheduled Monetary Policy Meeting will be held on April 10, 2012.

BOJ calendar of monetary policy meetings can be found at:

Bank of England

On March 8, 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 totaling £325 billion financed by the issuance of central bank reserves. 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 £50 billion, taking place on February 9, 2012.

According to the Office for National Statistics (ONS), GDP fell by 0.2 percent in the fourth quarter of 2011, driven by a sharp fall in business investment and lower stock-building. GDP growth over 2011 as a whole was estimated to have been 0.8 percent, with the weakness in GDP growth attributed largely to a 0.6 percent contraction in household consumption over the year. Similarly, business investment contracted in 2011 though the fall was not broadly based, and business investment could pick up sharply as companies gain more confidence.

Meanwhile, the unemployment rate had risen to 8.4 percent in the last quarter of 2011, broadly as expected, though it remains significantly higher than the average of around 5.5 percent seen over the decade prior to the recession. Despite CPI annual inflation falling to 3.6 percent in January from its September peak of 5.2 percent, inflation is still more than double its target of 2 percent. While the January drop in inflation had been as expected, there was less certainty about the extent and pace at which inflation would subsequently fall.

Overall, the Committee judged that recent data was in line with expectations and that there had been little change to the balance of risks to U.K activity and inflation. Based on this assessment, the Committee determined that a change in either bank rate or asset purchase size was not warranted.

BOE Interest Rates versus Expected Price Moves: March 30, 2012

Central_Bank_Interest_Rate_Outlook_March_2012_body_Picture_3.png, Central Bank Interest Rate Outlook March 2012

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

Looking forward, it is clear that the BOE’s Committee is focused on economic growth in conjunction with reducing inflation. Although the Committee sees inflation easing to manageable levels in the coming years, it noted short-term inflationary risks due to rising crude oil prices and upward wage pressures. Based on this uncertainty, the Committee will likely hold the bank rate at 0.5 percent at the next meeting on April 8, 2012. Furthermore, with two of the nine Committee members voting to increase the size of the asset purchase program at the March meeting, there could be scope for further easing in April.

BOE Statements can be found at:

European Central Bank

At its meeting on March 8, 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 third consecutive meeting decision to keep rates unchanged, after successive 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 survey indicators confirm signs of a stabilization in the euro area economy, ‘the economic outlook is still subject to downside risks’. Furthermore, due to rising energy prices and indirect taxes, ‘inflation rates are now likely to stay above 2 percent in 2012, with upside risks prevailing’. Meanwhile, the underlying pace of monetary expansion remains subdued, consistent with contained inflationary pressures over the medium term. Reaffirming the ECB’s commitment to maintaining price stability in line with its mandate, Draghi stated that ‘the continued firm anchoring of inflation expectations – in line with our aim of maintaining inflation rates below, but close to, 2 percent over the medium term – is of the essence’.

Since the last monetary policy meeting in February, the ECB launched a second round of three-year longer-term refinancing operations (LTRO) worth 530 billion euros to provide further support for the ongoing stabilization in financial markets and lending activity in the euro area. Draghi noted that these temporary measures, together with fiscal consolidation and tighter structural reforms, have contributed to a significant improvement in the financial environment over recent month.

Economic and monetary analyses were the underlying determinants of maintaining the rate unchanged at 1.00 percent. The underlying pace of monetary expansion remains subdued, with the annual growth rate of M3 rising to 2.5 percent in January from 1.5 percent in December. Real GDP in the euro zone shrank by 0.3 percent in the fourth quarter of 2011 after growing by 0.1 percent in the previous quarter. Although recent survey data showed signs of economic activity, albeit at low levels, the ECB expects the euro area economy to recover gradually through 2012, though ongoing tensions in euro area sovereign debt markets are expected to continue to dampen the underlying growth momentum.

With regards to price developments, Eurostat estimated that Euro area annual HICP inflation was 2.7 percent in February, up slightly from 2.6 percent in January. Inflation is now likely to stay above 2 percent in 2012, due to recent energy prices and indirect taxes, and fall again to below 2 percent in early 2013. The ECB expects that risks to the medium-term outlook for price developments remain ‘broadly balanced’ with upside risks in the near term stemming from the higher oil prices and tax increases. However, ‘downside risks continue to exist owing to weaker than expected developments in economic activity’.

ECB Interest Rates versus Expected Price Moves: March 30, 2012

Central_Bank_Interest_Rate_Outlook_March_2012_body_Picture_2.png, Central Bank Interest Rate Outlook March 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 on April 4 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 urgent need for euro area governments to make further progress with fiscal consolidation and enforce implementation of structural reforms in order to ‘increase the adjustment capacity and competitiveness of euro area countries and to strengthen growth prospects and job creation’.

ECB Statements can be found at:

Bank of Canada

At its March 8, 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 January Monetary Policy Report (MPR), uncertainty around the global economic outlook has decreased, as tentative signs of stabilization in European bank funding and sovereign debt markets have led to some improvements in global financial markets and a decrease in risk aversion. Nonetheless, the global economy is still expected to grow below its trend rate. Core and total CPI inflation have firmed due to reduced economic slack and increased oil prices. However, as these factors moderate in the second quarter, inflation is expected to return to around 2 percent, in line with the Bank’s target inflation target level over the medium term.

BOC Interest Rates versus Expected Price Moves: March 30, 2012

Central_Bank_Interest_Rate_Outlook_March_2012_body_Picture_10.png, Central Bank Interest Rate Outlook March 2012

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

Looking forward, the Bank’s overall outlook for the Canadian economy has improved slightly from the January MPR. Although the economy is likely to grow faster than forecast in the first quarter of 2012, underlying economic momentum remains around trend, balancing domestic strength and external weakness. Private demand is expected to be slightly stronger than forecasted, boosted by improved sentiment and financial conditions. Meanwhile sustained high levels of household spending relative to GDP may add to domestic debt burden. Stronger-than-anticipated U.S. activity has boosted net exports, though this is expected to contribute little to growth, reflecting still-moderate foreign demand and persistent high valuation of the Canadian dollar.

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 and financial 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 on April 17 seems unlikely.

BOC press releases on monetary policy:

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