Central Bank Watch: June 13, 2013 Update
Highlights of Latest Policy Meetings:
The Federal Reserve
The statutory mandate of the Federal Reserve seeks to foster maximum employment and price stability. In context of the recent expansionary monetary policy program, QE3, the Fed has designated an Unemployment Rate less than or equal to 6.5% sufficient to consider winding down QE3, or if yearly inflation as measured by the Consumer Price Index and the Core PCE exceeds +2.5%. (This is known as “The Evans Rule.”)
Recent economic data suggests that economic activity has been expanding at a moderate pace in the US. Labor market conditions have shown improvement in recent months, as the headline May Change in Nonfarm Payrolls beat economic forecasts at +175K versus +163K expected. Household spending and fixed business investment rose, and the housing sector revealed promising signs of recovery.
Further, Standard & Poor’s Financial Services, the US credit rating agency that downgraded the US from ‘AAA’ to ‘AA+’ in August 2011, recently upgraded its credit outlook for the United States government to “stable” from “negative.” This implies that there is a one-in-three chance of an upgrade or a downgrade in the rating over the next several months. Overall, however, with the Unemployment Rate remaining relatively high at 7.6%, uncertainty lingers over tapering the Fed’s quantitative easing policy.
Currently the Fed is utilizing a rather unconventional monetary policy in order to stimulate the national economy. An $85 billion-per-month asset purchase program, which has provided support for a slow recovery, has been used to pump liquidity into financial markets and keep interest rates low. The next Fed policy meeting is on June 19.
Bank of Japan
After the June 4 monetary policy meeting, the Bank of Japan announced that it will continue current money market operations for the intermeeting period. The BoJ will continue increasing the annual monetary base by about 60-70 trillion yen through a program of asset purchases. In particular, the BoJ remains on track to purchase Japanese government bonds (JGBs) in order to increase the amount outstanding by an annual pace of ¥50 trillion, having the remaining average maturity of these purchases at seven years.
Further, the BoJ will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) to add ¥1.3 trillion to the amount outstanding annually. Simultaneously, the Bank will continue CP and corporate bond purchases until their amounts outstanding reach ¥2.2 trillion and ¥3.2 trillion respectively by the end of 2013. Hereafter, these amounts outstanding will be maintained.
Consequently, the Japanese economic outlook is expected to follow a moderate recovery path, as the effects of monetary easing have spurred domestic demand. This may be exemplified in the relative strength of the Yen following the BoJ’s rate decision: ‘Abenomics’ is boosting GDP and inflation expectations are improving. However, lingering uncertainty regarding the European debt crisis and the growth momentum of the US economy prove to be limiting factors in obtaining a vivid picture of Japanese economic prosperity.
European Central Bank
On June 6, theEuropean Central Bank revealed an up to date economic and monetary analysis regarding the Euro-zone, and the tone remained disappointing overall. Among top headlines, ECB President Mario Draghi announced that the key interest rate would be on hold at 0.50%, while the deposit facility rate was held at 0.00%. Ahead of the meeting, speculation had arisen that the ECB would cut its deposit rate to negative territory, so no change was seen as a positive for the Euro. As per the ECB, volatility measures reveal that underlying price pressures over the medium-term are expected to be subdued, reflecting a slow pace of economic recovery.
Furthermore, inflation expectations in the medium term are intertwined with price stability, which foresee annual HICP inflation at +1.4% and +1.3% in 2013 and 2014, respectively. Accordingly, signs of economic stability have surfaced as economic data compiled alongside monetary data reveal price developments are projected to remain in line with price stability over the medium-term. Stable inflation expectations played a role in the ECB’s decision to keep its policy on hold this past meeting.
Under this current monetary policy, the Governing Council of the ECB has established a set of technical features for outright transactions in secondary markets for government bonds. The European Financial Stability Facility (EFSF)/European Stability Mechanism (ESM) programs are conditionally utilized in a strict manner, and set the preconditions for conducting OMT transactions (although there have yet to be any transactions under the OMT scheme.) Any monetary transactions will focus on the shorter-end of the yield curve, particularly government bonds with a maturity between one- and three-years. There are no quantitative limits set on outright monetary transactions and any liquidity generated by this policy is to be fully sterilized by targeted operations.
At present time, it is the collective opinion of DailyFX Research that a shift to negative deposit rates by the ECB – a significant factor in the Euro’s weakness between late-February and late-May – is unlikely to occur in the near-term. Accordingly, this is one fewer bearish factor influencing the Euro, which is supportive of the Euro henceforth. Should negative deposit rates become a viable option in the future, we believe that the Euro would face immediate and intense negative pressure.
The Bank of Canada
On May 29, the Bank of Canada announced that it would uphold the overnight target rate it previously established. At present time, the main bank rate is 1.25% and the deposit rate is 0.75% . This decision, predicated on recent labor market reports, , has revealed that growth in the 1Q’13 was stronger than the BoC projected in April. In particular, Canadian employment figures showed a staggering jobs gain for the Canadian economy as employment rose by +95K in May, beating expectations of a +15K jobs gain. This figure stands as the most significant jobs growth since August 2002, and it dropped the domestic unemployment rate from 7.2% to 7.1%, despite a noteworthy jump in labor market participation, which is typically the sign of a structurally improving labor market. Should the gains hold in coming months, these data are supportive of a stronger Canadian Dollar over the medium-term.
Core inflation in Canada remains in line with the BoC projections made in April. However, muted core inflation reflects material excess of supply in the economy, heightened competitive pressures in the retail sector, and some special forces such as slower increases in regulated prices. Consequently, headline CPI inflation has been restrained by low core inflation and declining mortgage costs. Reflective of these factors, the BoC will maintain a monetary policy of stimulus already in place for the time being. The economy is expected to assume a +2.0% yearly inflation rate by mid-2015, as projections reveal Canada to be at full economic capacity. Similarly, at present time, it is of the collective opinion of DailyFX Research that the next major shift in BoC monetary policy will be an interest rate hike in mid- to late-2014.
Bank of England
In the UK, economic recovery remains weak and uneven. CPI inflation remains above the Bank of England’s +2.0% yearly target and is poised to remain above target, for the next two years as a result of the weaker British Pound and the BoE’s accommodative monetary policy remaining in place over said time frame. The BoE’s key interest rate remained at 0.50% as the Monetary Policy Committee continued its asset purchase program of £375 billion.
Domestic demand increases in 2012 proved to be offset by declines in exports, as growth in world demand slowed altogether, particularly in the Euro-zone, Britain’s most important trading partner. Forecasts reveal a yearly GDP increase of +0.3% in 2013, and projections call for a moderate increase in GDP growth over the course of this year. Further, employment growth has slowed of recent, and indications from decreasing labor productivity reveal that the effective capacity of the economy to supply goods and services may be impaired.
In response to such shocks in the UK economy, the BoE continues to confront a trade-off between the speed to which inflation is returning to the +2.0% yearly target and the support that monetary policy can provide to output and employment. Currently, monetary policy remains highly stimulatory as the MPC believes this policy is best to meet the +2.0% yearly CPI target while providing support toward economic recovery in the medium-term.
Reserve Bank of Australia
The Australian economic growth outlook has changed little from the Reserve Bank of Australia’s policy statement released in February 2013. GDP growth is expected to be below trend over 2013, before picking up pace in 2014. The quarterly rate of CPI inflation declined in the 1Q’13 to a seasonally adjusted basis of +0.1%, while the yearly CPI inflation rate was +2.5%.
These data are indicative of price increases from the introduction of the carbon price and alterations in private health insurance rebate in the previous year, not necessarily improved demand in the Australian economy. Stimulatory monetary policy has catalyzed improving conditions in the housing market, while population growth is anticipated to support investment and household spending more generally. Labor market conditions are expected to remain subdued in the near-term as the global commodity supercycle slows; the mining sector is Australia’s largest.
At the May 8 meeting, the cash rate was lowered by 25-bps to 2.75%. Policy was steady at the June 4 meeting, but the RBA’s overall tone was slanted dovish. In light of slower growth rates, declining inflation rates, and subdued credit growth, accommodative policy is viewed as the most acceptable measure to promote growth in the economy while achieving the inflation rate target. Another rate cut this year should not be ruled out if Chinese growth prospect continue to suffer.
Reserve Bank of New Zealand
On June 12, 2013, the Reserve Bank of New Zealand left the Official Cash Rate (OCR) unchanged at 2.50% as a result of a slowly improving domestic economy alongside subdued global growth prospects. Domestically, economic recovery remains uneven as demand and output have expanded in the face of a steady labor market. In particular, the housing market continues to heat up, which is a central concern for the RBNZ, with Governor Graeme Wheeler suggesting that the central bank could use its “macroprudential tools” to prevent a housing bubble from forming. Economic growth projections occur at an annual rate of +2% to +3% over the forecast period, with inflation expected to rise at a gradual pace toward the target mark of 2%.
The overvalued New Zealand Dollar continues to undermine profitability in export and import competing industries, as per recent comments from RBNZ Governor Wheeler. The RBNZ’s governor has gone so far as to say that should the Kiwi remain overvalued, the RBNZ could intervene to weaken the currency.
Swiss National Bank
On March 14, 2013, the Swiss National Bank left the minimum exchange rate of EURCHF at Sf1.20 unchanged. An appreciating Swiss Franc may compromise price stability for the Swiss economy. Thus, the SNB is adamant about strictly enforcing this rate and is prepared to buy foreign currency in unlimited quantities for this purpose. Further, the SNB left the target range for the 3-month Libor unchanged at 0.00% to 0.25%.
The SNB is expecting a yearly inflation rate of -0.2% for 2013 and +0.2% for 2014. Growth is projected at +1.0% to +1.5% for Switzerland in 2013, which reveals a modest pace, meaning there’s a very high probability that the EURCHF floor is maintained over the course of 2013. Ultimately, Switzerland faces risk tensions that the Euro-zone will rise again, and altogether remains vulnerable to the global economic situation and sentiment on financial markets.
--- Written by Christopher Vecchio, Currency Analyst, and Jonathan DePaolis, DailyFX Research
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