Monday, 10 December 2007

The Fed has company but it's not the BoJ

The Federal Reserve is set to announce its decision on monetary policy tomorrow. Investors and economists expect a 25 basis point cut. If the Fed meets this expectation, it would be doing so in the knowledge that it is no longer alone among major central banks in cutting interest rates.

The past week saw central banks garner much of the attention in markets as three central banks representing five of the Group of Seven economies made interest rate decisions, with two of the three choosing to cut interest rates.

On 4 December, the Bank of Canada announced that it was lowering its target overnight lending rate by 0.25 percentage point to 4.25 percent. It cited global financial market difficulties and a weaker outlook for the United States economy as posing downside risks to its inflation projection.

On 6 December, the Bank of England announced that it was cutting its official bank rate by 0.25 percentage points to 5.5 percent. It cited a deterioration in financial markets and credit tightening as posing downside risks to the outlook for both output and inflation.

The European Central Bank though chose to keep its refinancing rate unchanged at 4 percent. If anything, it appears more likely to hike rates next rather than cut them. In a press conference after its meeting on 6 December, President Jean-Claude Trichet said that "there are upside risks to price stability over the medium term" and "some" voices among Governing Council members in favour of a rate increase.

Among other central banks, Indonesia's also cut its benchmark interest rate last week by 0.25 percentage point to 8.0 percent.

So on the whole, global central bank policy rates appear to have peaked. However, the trend is far from uniform.

On 6 December, the South African Reserve Bank raised its repurchase rate by 50 basis points to 11.0 per cent, citing upside risks to the inflation outlook.

Over the weekend, the People's Bank of China announced that it was raising the reserve requirement ratio for commercial banks by one percentage point. This followed an announcement at the 2007 Central Economic Work Conference earlier last week that it was shifting its monetary policy from "prudent" to "tight".

Another central bank that still appears to be leaning towards tighter monetary policy is the Bank of Japan. The BoJ's monetary policy meeting is scheduled for next week. It has not raised interest rates since February as inflation in consumer prices has been almost non-existent so far this year while economic growth, already weak at an annualised rate of 1.5 percent in the third quarter, is threatened by the on-going global financial market turmoil.

Having said that, the Cabinet Office reported today that Japanese core private-sector machinery orders, a measure of corporate capital spending, rose 12.7 percent in October from the previous month.

While the economic data have been somewhat ambiguous, BoJ officials have not softened their rhetoric much recently.

Last week, Governor Toshihiko Fukui said in a speech to business leaders in Nagoya that with economic growth "expected to continue at a rate somewhat higher than the potential growth rate", consumer prices is "expected gradually to rise in the longer run". More explicitly on monetary policy, he said that "Japanese financial conditions have been extremely accommodative, and if Japan's economy is to follow a path of sustainable growth under price stability, the level of interest rates is to be raised".

Back in September, Miyako Suda, a member of the Policy Board, had said much the same thing in another speech, adding -- in stark contrast to the attitude of officials at the Federal Reserve -- that "it is difficult for an economy to achieve a soft landing by monetary policy measures alone once concerns about the possible bursting of the bubble start to strengthen" and that therefore, "it is important for a central bank to preempt the emergence of an asset price bubble".

Clearly, where you want to go depends on where you came from.

With the Federal Reserve now widely expected to keep cutting interest rates in an attempt to keep a credit crunch at bay, time will tell whether it is the Fed or the BoJ who has the right road map.

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