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Central Bank Interest Rate Outlook June 2012

Central Bank Interest Rate Outlook June 2012

Tzu-Wen Chen, Technical Strategist

Central Bank Interest Rate Outlook

Central_Bank_Interest_Rate_Outlook_June_2012_body_Picture_9.png, Central Bank Interest Rate Outlook June 2012

Written by Tzu-Wen Chen, DailyFX Research

Highlights of Latest Policy Meetings:

Federal Reserve

In a statement released on April 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 moderately since the FOMC’s last monetary policy meeting in March, with most Committee participants expecting economic growth to remain moderate over coming quarters before picking up gradually.

On the upside, manufacturing production expanded in February and March, boosted by increased motor vehicle production. On the downside, ongoing weakness in the housing sector continues to pose a ‘headwind for recovery’. Strains in global financial markets also continue to produce significant risks to the economic outlook.

On the labor market front, conditions have improved in recent months and the unemployment rate had declined. However, at 8.2 percent as of March, it remains elevated. Looking ahead, the Committee expects that the jobless rate will decline gradually over the next few years, with projections of 7.8 to 8.0 percent in the fourth quarter of 2012, before declining to 6.7 to 7.4 percent in the fourth quarter of 2014.

Consumer price inflation had increased somewhat, reflecting higher prices of crude oil and gasoline. However, this is expected to be only temporary, with longer-term inflation expected to remain stable and the FOMC reiterating that it anticipates that inflation will subsequently run at or below the Committee’s longer-run target of 2 percent. The FOMC’s latest projections of inflation have a central tendency of 1.9 to 2.0 percent for 2012 and 1.7 to 2.0 percent for 2014.

FED Interest Rates versus Expected Price Moves: June 11, 2012

Central_Bank_Interest_Rate_Outlook_June_2012_body_Picture_8.png, Central Bank Interest Rate Outlook June 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 June 20, 2012.

FOMC Statements and Calendar can be found at:

Reserve Bank of Australia

At its meeting on June 5, 2011, the Board of the Reserve Bank of Australia decided to lower its cash rate by 25 basis points to 3.50 percent. This marks the second consecutive rate cut, following a 50 basis points cut in May that brought the cash rate down to 3.75 percent from 4.25 percent. The Board’s decision to lower rates was based on modest domestic growth and a weaker and more uncertain international environment. Financial market sentiment has deteriorated over the past month, with further weakening in Europe and moderation in growth in Chinese expected to dampen global economic growth.

Domestically, growth in the first part of 2012 has been modest, while overall labor conditions have firmed somewhat. The unemployment rate, at 4.9 percent as of April, remains low. The housing market remains generally subdued, despite some signs of stabilization around the turn of the year.

On the price front, inflation is expected to be in the 2-3 percent range over the coming one to two years. In the near term, inflation is likely to remain in the lower part of this range, though maintaining low inflation over the longer term will require slower growth in domestic costs as the effects of the earlier high exchange rate diminish. The high valuation of the Australian dollar has fallen in recent weeks, reflecting lower commodity prices, heightened risk aversion and expectations of further rate cuts.

RBA Interest Rates versus Expected Price Moves: June 11, 2012

Central_Bank_Interest_Rate_Outlook_June_2012_body_Picture_7.png, Central Bank Interest Rate Outlook June 2012

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

Looking forward, we could see further rate cuts if domestic and international economic stability and growth continue to deteriorate. At the June meeting, the Board judged that “the outlook for inflation afforded scope for a more accommodative stance of monetary policy”. The outlook for inflation remains little changed from the forecasts published in the May Statement, with the Bank expecting inflation to stay close to recent rates and be in the 2-3 percent range over the coming one or two years. The next rate decision meeting is scheduled for July 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 April 25, 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 is restrained and is expected to stay near the middle of the Bank’s target range’.

Domestically, the economy is showing signs of recovery, with housing market activity continuing to increase and recovery in building activity underway as forecast. This recovery is likely to strengthen as repairs and reconstruction work following the earthquake in Canterbury in 2011 pick up later in the year. On the other hand, the global outlook continues to be of concern and financial market sentiment remains fragile despite some moderation in near-term indicators.

Bollard noted his concerns over the New Zealand dollar, which has remained elevated despite recent falls in commodity prices. While the high value of the New Zealand dollar helps contain inflation, it has a negative impact on the tradable sector, undermines GDP growth and inhibits rebalancing in the New Zealand economy.

RBNZ Interest Rates versus Expected Price Moves: June 11, 2012

Central_Bank_Interest_Rate_Outlook_June_2012_body_Picture_6.png, Central Bank Interest Rate Outlook June 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. Bollard noted that “should the exchange rate remain strong without anything else changing, the Bank would need to reassess the outlook for monetary policy settings”. The next monetary policy decision meeting is scheduled for June 13, 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: June 11, 2012

Central_Bank_Interest_Rate_Outlook_June_2012_body_Picture_5.png, Central Bank Interest Rate Outlook June 2012

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

Looking forward, the SNB 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 May 22, 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 decided to maintain the size of its Asset Purchase Program at about 70 trillion yen, while changing the composition of assets in its program. The last injection of monetary easing was by 5 trillion yen in April 2012.

Overall, Japan’s economic activity has remained more or less flat, though it has become increasingly evident that Japan’s economy is shifting toward a pick-phase. Exports and production have remained largely unchanged, though there have been some signs of a pickup in production. On the upside, domestic public investment has been increasing while business fixed investment has been moderately increasing with some improvement in business sentiment. Private consumption and housing investment have also been picking up. On the other hand, labor market conditions continue to be severe, although there have been signs of improvement with a generally downward trending jobless rate. Meanwhile, domestic financial conditions have continued to ease.

On the price front, the year-on-year rate of change in core CPI is around 0 percent. The three-month rate of change in domestic corporate goods prices is increasing moderately, predominantly due to the earlier increase in global commodity prices.

BOJ Interest Rates versus Expected Price Moves: June 11, 2012

Central_Bank_Interest_Rate_Outlook_June_2012_body_Picture_4.png, Central Bank Interest Rate Outlook June 2012

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

Looking ahead, Japan’s economy is expected to return to a moderate recovery path as recovery of global economies gain pace, led by emerging and commodity-exporting economies, and as reconstruction-related demand after the earthquake in March 2011 gradually strengthens. Exports are expected to gradually increase, reflecting a pick-up in global economic recovery. Domestically, public investment and housing investment should continue to pick up, while private consumption is expected to remain firm as the labor market gradually improves.

On the price front, the year-on-year rate of change in core CPI is projected to remain around 0 percent for the time being. In its April Outlook for Economic Activity and Prices report, the Board projected that core CPI will gradually rise to between 0.5 and 1 percent in the latter half of 2013, as aggregate supply and demand balance improves. Shortly thereafter, the Board expects that the rate will reach the Bank’s “price stability goal in the medium to long term” 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 overcome deflation and 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 support private financial institutions in their efforts to strengthen the foundations for Japan’s economic growth via the Growth-Supporting Funding Facility. The next scheduled Monetary Policy Meeting will be held on June 15, 2012.

BOJ calendar of monetary policy meetings can be found at:

Bank of England

On June 7, 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), the U.K. fell into a double dip recession as first quarter GDP shrank by 0.3 percent, following a contraction by the same amount the previous quarter. The drop in GDP was predominantly due to weakness in construction output. On the other hand, the services sector continued its pace of expansion in May, signaling some strength in the economy.

On the labor market front, employment conditions remained broadly steady, with full-time employment showing a small decline over the past year while part time employment increased. Overall, the labor market and real GDP growth has been subdued. Underlying demand growth is likely to remain subdued in the near term, before a modest increase in households’ real incomes and consumptions helps boost recovery.

On the price front, CPI inflation stood at 3.0 percent in April, down from a peak of 5.2 percent in September 2011, as the effects of earlier increases in energy prices and VAT dropped out of the twelve-month inflation rate. In its May Inflation Report, the Bank noted that prospects for inflation are uncertain. The Bank raised its near-term outlook, with inflation now likely to remain above the 2 percent target for the next year or so, before gradually falling back to around the target inflation rate.

In response to the threat of above-target inflation, the Bank decided to leave its stimulus plan on hold despite heightened uncertainty and risk to the U.K. economy from Europe’s debt crisis.

BOE Interest Rates versus Expected Price Moves: June 11, 2012

Central_Bank_Interest_Rate_Outlook_June_2012_body_Picture_3.png, Central Bank Interest Rate Outlook June 2012

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

Looking forward, the possibility of further monetary stimulus in the coming months cannot be ruled out, with GDP growth likely to remain weak in the near term and strengthen only gradually thereafter. There is a possibility of more aggressive loosening of policy in the near-term if weak domestic growth persists. Conversely, if the likelihood of inflation remaining above target in the medium term increases, the Committee could subsequently withdraw some of its monetary stimulus. It appears that the bank has adopted a “wait-and-see” approach for the time being, as the ongoing crisis in Europe continues to pose downside risks to the U.K. and global economies. The next scheduled Monetary Policy Meeting will be held on July 5, 2012.

BOE Statements can be found at:

European Central Bank

At its meeting on June 6, 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 sixth 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 warned of increased downside risks to the economic outlook, with economic growth in the euro area remaining weak and heightened uncertainty weighing on confidence. Real GDP growth was flat in the first quarter of 2012, with indicators pointing to weakening growth in the second quarter. Beyond the short term, the ECB expects the euro area economy to recover gradually. However, ongoing tensions in the debt markets, the process of balance sheet adjustment in the financial and non-financial sectors and high unemployment will likely continue to dampen the underlying growth momentum.

With regards to price developments, euro area annual HICP inflation had fallen to 2.4% in May from 2.6% the previous month. Inflation rates are likely to stay above 2 percent in 2012 before falling below 2 percent in early 2013. The underlying pace of monetary expansion remains subdued, while inflation expectations for the euro zone economy continues to be “firmly anchored” in line with the ECB’s goal of maintaining rates below, but close to, 2 percent over the medium term. Risks to inflation outlook are “broadly balanced”.

Also included in the introductory statement were the ECB’s June macroeconomic projections for the euro area. The ECB’s 2012 annual real GDP growth projections remain unchanged at a range between -0.5 percent and 0.3 percent, while its 2013 growth projection range was narrowed to between 0.0 and 2.0 percent. In terms of price pressures, the ECB revised its 2012 inflation range to between 2.3 and 2.5 percent (previously estimated between 2.1 and 2.7 percent), and its 2013 inflation range to between 1.0 and 2.2 percent (previously estimated between 0.9 and 2.3 percent).

ECB Interest Rates versus Expected Price Moves: June 11, 2012

Central_Bank_Interest_Rate_Outlook_June_2012_body_Picture_2.png, Central Bank Interest Rate Outlook June 2012

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

Looking ahead, there is a possibility of an interest rate cut at the next meeting on July 5, 2012 should economic conditions deteriorate further. At the June meeting, a few council members had called for a rate cut, adding pressure on the ECB to lower rates in the near term.

Looking at the ECB’s monetary policy measures, the Bank will continue to conduct their main refinancing operations (MROs) as fixed rate tender procedures with full allotment for “as long as necessary”. Draghi reiterated that the non-standard measures are temporary and the ECB will monitor further developments closely, taking action in a firm and timely manner as required. Although he acknowledged that the ECB’s Long-Term Refinancing Operations (LTROs) had prevented a credit crunch and further problems in the euro zone, he noted that the issue now was whether further LTROs would be effective.

In addition to discussing the ECB’s monetary policy, Draghi reiterated the need for euro area governments to address their own problems and make further progress with restoring sound fiscal positions. Draghi concluded, “In several euro area countries, excessive imbalances exist and need to be corrected. To this end, comprehensive product, labor and financial sector reforms will help foster sustainable growth.”

ECB Statements can be found at:

Bank of Canada

At its June 5, 2012 monetary policy meeting, the Bank of Canada decided 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.

The Bank softened its hawkish tone after hinting at its April meeting that the time to begin reversing the accommodative monetary policy may be approaching. The Bank’s decision to hold off on raising its benchmark rate was based on weakened global economic growth outlook and slower-than-expected domestic growth. Global financial conditions have deteriorated in recent weeks, as risks around the European crisis materialize. While the U.S. economy continues to expand at a modest pace, emerging-market economic activity is slowing faster and more broadly than expected. Commodity prices have consequently declined on heightened financial risk aversion.

Domestically, economic growth was slower than expected, with Canada’s GDP expanding at an annualized rate of only 1.9 percent in the first quarter compared to the Bank’s forecast of 2.5 percent. The composition of growth has become ‘less balanced’, with stronger-than-expected housing activity and households continuing to add to their debt burden amid modest income growth.

On the price front, total CPI inflation is expected to fall below 2 percent in the short term as a result of lower gasoline prices, while the Bank anticipates core inflation to remain stable at around 2 percent. The ‘persistent currency strength’ of the Canadian dollar poses an ongoing challenge, as the high valuation dampens foreign demand and net exports.

BOC Interest Rates versus Expected Price Moves: June 11, 2012

Central_Bank_Interest_Rate_Outlook_June_2012_body_Picture_1.png, Central Bank Interest Rate Outlook June 2012

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

Looking forward, Canadian policy makers will continue to endorse a ‘wait-and-see’ approach. Modest withdrawal of monetary policy stimulus may become appropriate, consistent with achieving the 2 percent inflation target over the medium term, as economic expansion continues and the current excess supply in the economy is gradually absorbed. The Bank noted that “the timing and degree of any such withdrawal will be weighed carefully against domestic and global economic developments”. The next scheduled Monetary Policy Meeting will be held on July 17, 2012.

BOC press releases on monetary policy:

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