Hawks linger in Europe, Fed still seen slashing rates

The economic reports yesterday were mostly unfriendly to bond investors.

In Europe, Sweden's central bank decided to raise interest rates again. Bloomberg reports:

Sweden's central bank unexpectedly raised its benchmark interest rate to 4.25 percent, the highest since November 2002, after inflation surged to a 14-year high last year on plunging unemployment and rising food costs.

The rate was raised by a quarter point and will remain "at roughly the same level over the coming year," Governor Stefan Ingves said at a press conference in Stockholm today. All 24 economists surveyed by Bloomberg expected an unchanged rate.

In the UK, although house prices fell in the three months to January and earnings rose less than expected in the three months to December, the Bank of England appears unlikely to cut interest rates aggressively. From Reuters:

British interest rates won't fall as sharply this year as financial markets have predicted, the Bank of England signaled on Wednesday, although at least one more cut in borrowing costs is probably still on the cards.

The BoE's quarterly inflation report showed inflation way above the central bank's 2 percent target in two years if rates fell as far as 4.5 percent by the end of 2008. But inflation would probably fall below 2 percent if they stayed at their current 5.25 percent.

In the US, where the Federal Reserve has cut rates aggressively, retail sales were actually up in January. Bloomberg reports:

Retail sales in the U.S. unexpectedly rose in January, easing concern that the world's largest economy has already slipped into a recession.

The 0.3 percent increase was led by spending on autos, clothes and gasoline, the Commerce Department said today in Washington. The figure followed a 0.4 percent decrease the previous month. Purchases excluding automobiles and gasoline were unchanged from December.

The retail sales figure hasn't changed the view that the Fed will continue to cut rates. From Bloomberg:

Treasury two-year notes yielded the least compared with benchmark 10-year debt since 2004 on speculation credit-market losses will widen.

Yields on three-month Treasury bills, viewed by investors as a haven in times of turmoil, dropped for the first time in five days. Reluctance by banks to risk capital by buying unsold auction-rate municipal bonds increased demand for the relative safety of the shortest-term government securities...

Interest rate futures on the Chicago Board of Trade showed a 32 percent chance the Fed will reduce the 3 percent target rate for overnight lending between banks by three-quarters of a percentage point at its March 18 meeting, compared with 20 percent odds yesterday. The rest of the bets are for a half- point cut. The Fed has cut the target lending rate five times since September to prevent the world's largest economy from falling into a recession.