Thursday 23 August 2007

World markets calmer, ECB may proceed with rate hike

From FT:

World markets enjoyed a calmer session on Wednesday as US investors put aside credit concerns to focus on the possibility of the Federal Reserve cutting interest rates.

Global equities made solid gains, government bonds retreated and the low-yielding Japanese yen lost ground, suggesting a tentative return of risk appetite.

Macro Man thinks that "the medium-term prognosis for risky assets remains broadly constructive", although "another noisy dip is very likely".

The rationale for the generally upbeat view of risk assets, meanwhile, rests on one word: liquidity. While asset markets have clearly seen a sharp reduction in the amount of micreconomic liquidity available (in other words, the amount of trading that can be done in asset markets without producing catastrophically expensive transaction costs), on a macroeconomic basis, liquidity remains ample.

Which is probably why the ECB has indicated that it is likely to proceed to hike rates next month. From Bloomberg:

The European Central Bank indicated it may still raise interest rates in September and announced an extra 40 billion euros ($54 billion) three-month loan to ease lending between commercial banks.

The Frankfurt-based bank responded to speculation that it may hold off raising interest rates on Sept. 6 by saying it's sticking to the policy stance expressed by President Jean-Claude Trichet on Aug. 2. At the time, Trichet pledged to show "strong vigilance" on inflation, a phrase he has used to signal each of the eight rate increases since late 2005.

Investors need to be careful over the next few weeks. With traders expecting a rate cut from the Fed soon, failure by the Fed to deliver such a cut could upset markets. In the meantime, most other major central banks still appear to be maintaining a tightening bias, which could adversely affect near-term liquidity despite the more benign prognosis for the longer term.

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