Thursday 22 March 2007

Fed holds rates steady, relaxes tightening bias

The Fed yesterday gave markets more or less what they wanted short of actually cutting interest rates. Reuters reports:

The U.S. Federal Reserve held interest rates steady on Wednesday and said it remained concerned about inflation, but dropped its reference to the possibility of pushing rates higher, leaving its options open.

The decision by the central bank's Federal Open Market Committee to keep benchmark overnight rates at 5.25 percent, the level they hit in June after 17 straight quarter-percentage point increases, was widely expected.

However, in a shift that markets saw as evidence that the Fed is no longer leaning toward higher rates, officials said that "future policy adjustments would depend on the evolution of the outlook for both inflation and economic growth."

That marked a change from January, when the Fed had said "the extent and timing of any additional firming that may be needed" would depend on the outlook...

Financial markets took the new language as opening the door to lower interest rates.

U.S. stock prices jumped higher and the blue chip Dow Jones industrial average closed up 159 points. At the same time, the dollar hit a two-year low against the euro, and bond prices rallied, with yields on short-dated maturities dropping below yields on longer-dated issues for the first time since August.

As usual, Mark Thoma at Economist's View looks at other differences between the previous statement and the latest one. As for the market reaction, The Bonddad Blog disagrees with the response to the Fed statement, pointing out that the Fed is still concerned about inflation and is "not lowering rates anytime soon".

But then investor exuberance isn't unique to the US. Remember the Chinese stock market, the one that triggered the global market turmoil a few weeks back? Well, it's back at a record high. Bloomberg reports:

Shanghai stocks, whose drop in February sparked a global sell-off, climbed to a record.

The Shanghai Composite Index, which tracks the bigger of China's two stock exchanges, rose 0.8 percent to 3057.38, its highest-ever close. An 8.8 percent decline in the index on Feb. 27 set off a rout that erased $3.3 trillion of stock value in markets worldwide.

And remember that this is despite China having raised interest rates over the weekend.

Meanwhile, in another development that could be positive for markets, the Bank of England raised doubts that it would raise rates further. From Reuters:

Bank of England policymakers unexpectedly voted 8-1 for steady interest rates in March, with David Blanchflower wanting a 25 basis point cut, minutes showed on Wednesday, calming some fears that rates will soon rise...

Interest rate futures rallied after the surprise vote, while sterling fell and the FTSE 100 index of leading shares extended gains...

The minutes of the March 7-8 meeting showed the committee was content to leave rates unchanged this month, but said the short-term outlook for inflation was now slightly lower than in the February inflation report.

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