Wednesday, 16 April 2008

US turns less dovish, ECB reiterates hawkish stance

Opinion in the US appears to be shifting towards a less dovish stance on interest rates. From Bloomberg:

Most Federal Reserve banks, before the near-collapse of Bear Stearns Cos., favored a smaller reduction or no change at all in the charge for direct loans to banks than Fed governors approved last month.

Six of the 12 banks sought a half-point discount-rate cut before the March 14 announcement of emergency aid to Bear, while three asked for no change, according to minutes of Fed board meetings released today in Washington. The Fed board then lowered the rate by a quarter point on Sunday, March 16, and again by 0.75 percentage point at the regular meeting March 18.

The report may reinforce investor expectations that the Fed is unlikely to keep up this year's pace of interest-rate cuts, the fastest in two decades. Harvard University economist Martin Feldstein, an early advocate of aggressive rate reductions, called on the central bank today to halt the cuts.

Feldstein's views were detailed in a WSJ article.

It's time for the Federal Reserve to stop reducing the federal funds rate, because the likely benefit is small compared to the potential damage.

Lower interest rates could raise the already high prices of energy and food, which are already triggering riots in developing countries. In order to offset the inflationary impact of higher imported commodity prices, central banks in those countries may raise interest rates. Such contractionary policies would reduce real incomes and exacerbate political instability.

Similarly, Tim Duy argues that "given the increasingly clear link between monetary policy, the Dollar, and commodity prices, the Fed would be best to served to moderate the pace of easing".

And right on cue, yesterday's economic reports appear to justify such views. From Bloomberg:

U.S. producer prices rose almost twice as much as forecast and manufacturing in New York state unexpectedly grew, reducing the odds that the Federal Reserve will cut interest rates more than a quarter point this month.

Food and energy stoked the 1.1 percent gain in wholesale prices in March, the Labor Department reported today in Washington. The New York Fed's Empire State manufacturing index rose to 0.6 for April from minus 22.2, which was the lowest on record...

The National Association of Home Builders/Wells Fargo index of builder sentiment held at 20, the Washington-based group said today. The index reached a record low of 18 in December. Levels under 50 mean most respondents view conditions as poor.

In contrast to the Fed, the ECB doesn't need to be given such advice. From Bloomberg:

The European Central Bank signaled faster inflation will keep it from cutting interest rates even as investor confidence in Germany, Europe's largest economy, plunged.

ECB Executive Board member Juergen Stark said rates may not be high enough to contain inflation after French prices jumped 3.5 percent in March from a year earlier. Council member Nicholas Garganas said price pressure "is more intense than previously foreseen" and Miguel Angel Fernandez Ordonez said the ECB is "always more worried about inflation" than economic growth...

The ZEW Center for European Economic Research in Mannheim said today its index of German investor and analyst expectations declined to minus 40.7 from minus 32 in March. Economists expected a gain to minus 30.

Among the major central banks, the BoE remains the most likely to follow in the Fed's rate-cutting path after inflation in the UK held steady at 2.5 percent in March amid signs of a deteriorating economy as like-for-like retail sales fell in March and the RICS survey showed the most widespread fall in house prices last month in its 30-year history.

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