BoJ and Fed likely to stay sedate on interest rates

The central banks of Japan and the United States both left interest rates unchanged in January. Neither central bank has been very aggressive in moving interest rates either up or down recently, and this looks unlikely to change in the near future.

On 18 January, the Bank of Japan held its benchmark interest rate at 0.25 percent. The decision disappointed many analysts as it contradicted earlier signals that the BoJ was likely to hike rates at that particular meeting. Some attributed the decision to pressure from politicians unwilling to risk a deterioration in the economy.

However, data subsequently released arguably put the decision in a better light. Core consumer prices in Japan rose by just 0.1 percent in December from a year earlier, retail sales fell 0.3 percent, the biggest decrease in eight months, while household spending fell 1.9 percent.

Indeed, the trend of rising consumer prices is looking shaky at the moment with oil prices having been relatively weak over the past few months. And energy prices have been an important contributor to the overall inflation rate; core inflation excluding food and energy have actually not been able to move into positive territory in recent years.

Nevertheless, most analysts still think that the BoJ will hike rates this year. Interest rates remain low not only in absolute terms but in real terms while the overall economy continues to expand. And BoJ Governor Toshihiko Fukui himself has repeatedly indicated a willingness to raise rates, although it is likely to be at a very measured pace.

On 31 January, the Federal Reserve also decided to leave its target federal funds rate unchanged at 5.25 percent. In its accompanying statement, the Federal Open Market Committee noted the "somewhat firmer economic growth" and the moderate improvement in core inflation, concluding that "some inflation risks remain".

Indeed, on the same day, the US Commerce Department released its advance GDP report for the fourth quarter, showing a robust 3.5 percent expansion of the economy.

However, other data last week provided indications that rate cuts are not completely off the table either.

On 2 February, the Labor Department reported that the US economy added 111,000 jobs in January but the unemployment rate edged up to 4.6 percent. The recent bottom in the unemployment rate was in October at 4.4 percent.

A day earlier, the Institute for Supply Management reported that the PMI, its composite index measuring national manufacturing activity, eased to 49.3 in January from 51.4 in December. The January number was the second time in three months that the PMI has fallen below 50. A level below 50 indicates that manufacturing activity is generally declining.

The following charts show that increases in the unemployment rate and declines in the PMI have historically been closely followed by cuts in the federal funds rate.


Of course, it is also possible that the unemployment rate and PMI stabilise or even turn around from their recent trends. After all, the stock market has been strong, which has more often than not in the past pointed to a strong economy ahead. The Dow Jones Industrial Average has been on a record-breaking run, closing last week at another all-time high of 12,653.49. And its performance is now being duplicated by the Dow Jones Transportation Average, which also closed last week at an all-time high of 5,006.89, confirmation to some that the trend is positive.

So on balance, the Federal Reserve appears likely to remain on hold for some time to come.