Wednesday, 31 October 2007

Riksbank hikes rate, Fed likely to cut

Many central banks stopped tightening monetary policy after credit markets went into turmoil. Sweden's is not one of them. From the Riksbank's press release yesterday:

At its meeting on 29 October, the Executive Board of the Riksbank decided to raise the repo rate by 0.25 percentage points to 4 per cent. It is also probable that the interest rate will need to be raised slightly further in the future. During the first half of 2008 the repo rate is expected to be around 4.25 per cent. The Riksbank’s view of the future repo rate path remains largely the same as in June. The assessment is that the interest rate increases will contribute to an inflation rate in line with the 2 per cent target at the same time as production and employment develop in a balanced manner.

The Federal Reserve is expected to go in the opposite direction later today, especially after the latest economic reports. From Bloomberg yesterday:

The Conference Board's gauge of confidence declined to 95.6, the lowest since October 2005, from 99.5 in September, the New York-based group said today. Home values in 20 U.S. metropolitan areas slid 4.4 percent in the 12 months that ended in August, according to the S&P/Case-Shiller home-price index.

The figures heighten concern that consumers will put a brake on spending, which accounts for more than two-thirds of the economy. Fed policy makers will need to cut the target rate for overnight loans between banks tomorrow by a quarter point to 4.5 percent to prevent the housing recession from triggering a broader economic decline, some analysts said.

And the credit market turmoil may not even be over. From Bloomberg:

Banks shut out of the market for short-term loans are finding salvation in a government lending program set up to revive housing during the Great Depression.

Countrywide Financial Corp., Washington Mutual Inc., Hudson City Bancorp Inc. and hundreds of other lenders borrowed a record $163 billion from the 12 Federal Home Loan Banks in August and September as interest rates on asset-backed commercial paper rose as high as 5.6 percent. The government-sponsored companies were able to make loans at about 4.9 percent, saving the private banks about $1 billion in annual interest.

To meet the sudden demand, the institutions sold $143 billion of short-term debt in August and September, according to the FHLBs' Office of Finance. The sales pushed outstanding debt up 21 percent to a record $1.15 trillion, an amount that may become a burden to U.S. taxpayers because almost half comes due before 2009.

Like Fed rate cuts at the sign of any market distress, it is possible that this is only delaying the inevitable. Or maybe worse.

Yves Smith at naked capitalism comments that recourse to the FHLB means that "risk has been passed from institutions that could have been permitted to fail (or at least suffer) to one too big too fail. We'll learn all too soon whether this was a move that we will regret."

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