Wednesday, 17 January 2007

UK inflation at decade high, BoC holds rates, BoJ contemplates next move

We now have a better idea why the Bank of England raised interest rates last week. From Reuters:

British inflation accelerated to 3.0 percent last month, its highest since comparable records began a decade ago, handing the Bank of England a narrow escape from having to explain itself publicly to the government...

Retail price inflation rose to 4.4 percent, the highest since December 1991. Policymakers are worried that the rising cost of living will encourage inflationary pay demands in the crucial New Year bargaining round, triggering a wage-price spiral.

Meanwhile eurozone data continue to point to another rate hike in the not-too-distant future. From Bloomberg:

German investor confidence rose more than forecast to a six-month high in January as Europe's biggest economy overcomes a higher sales tax and a slowdown in export markets.

The ZEW Center for European Economic Research index of investor and analyst expectations for economic growth in six months rose to minus 3.6 from minus 19 in December. Economists forecast a gain to minus 10, according to the median forecast of 43 economists in a Bloomberg survey...

"At the moment, monetary policy is still accommodative," ZEW economist Matthias Koehler said at a briefing in Mannheim, Germany, today. "Interest rates are low, there is plenty of liquidity and the euro-area economies are in good shape."

The Bank of Canada, though, was content to leave interest rates unchanged yesterday. From CBC News:

As expected, the Bank of Canada left its key interest rate unchanged at 4.25 per cent Tuesday...

The central bank said it doesn't need to tinker with the rate because inflation is running largely as expected and economic growth should pick up in the first half of this year.

The Federal Reserve is also not likely to hike rates anytime soon, especially with the weakness in manufacturing as reflected in the latest Empire State Manufacturing Survey, which showed the general business conditions index falling sharply to 9.1 in January from 22.2 in December.

But the big debate on the direction of monetary policy remains on Japan, where industrial production for November has been revised to a 0.8 percent increase from a preliminary 0.7 percent but inflation pressures remain subdued. Reuters reports the latest data on wholesale prices in Japan:

Japanese wholesale prices rose 2.5 percent in December from a year earlier, matching the consensus forecast and doing little to change the view that the Bank of Japan (BOJ) could raise interest rates this week.

Growth in the corporate goods price index (CGPI), which tracks trends in wholesale prices of goods, slowed for the third straight month after a 2.7 percent increase in November, BOJ data showed on Tuesday...

Compared with a month earlier, the CGPI was flat in December, matching economists' consensus forecast.

This kind of data only add fuel to the debate on whether the BoJ should hike rates. From AFP/CNA:

"Pretty much everybody expects them to do it. Very few people think they should," said Robert Feldman, chief economist for Japan at Morgan Stanley.

"The issue for the BoJ is how they explain themselves and can they justify a rate hike when you have such low inflation? If they don't explain themselves clearly, then there will be some fireworks," he said...

"The BoJ has repeatedly said it will adjust policy rates gradually but if it fails to raise rates a full six months after last July's decision to end the zero interest rate policy, it will need to offer a convincing explanation to the markets," argued Barclays Capital strategist Masuhisa Kobayashi.

"If the economy continues its gradual recovery, the BoJ is likely to raise rates once every six months. But if the recovery's pace picks up even a little, we believe capital spending would strengthen and inflationary pressures would build, hastening the pace of rate hikes," he predicted.

Economic and Fiscal Policy Minister Hiroko Ota urged the BoJ this week to hold steady its super-low interest rates so as to stimulate the economy and decisively beat deflation.

"Japan is facing an extremely critical moment as it is finally getting out of deflation," she told a news conference...

Markets, meanwhile, are nervous that the central bank could repeat its blunder of August 2000, when it raised interest rates too soon and helped snuff out a nascent economic recovery.

"Things aren't as bad as they were in August 2000 but if consumer price inflation goes negative again, which it probably will in the spring, it's going to be very difficult for the BoJ to justify itself," said Feldman.

But perhaps BoJ officials have even longer memories and remember that the CPI was also pretty flat for much of the mid- and late-1980s. Was the BoJ right in keeping interest rates low then?

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