KIDS' GLOVES OFF !!!

Taking a tough stance on the spiraling inflation, RBI has announced a surprise hike in its key policy rates – repo and reverse repo –by a quarter percentage point each. This is the first increase in two years and more tightening measures are expected to follow as the central bank gears up to fight inflation. Post-increase, the repo rate stands at 3.5% and reverse repo rate at 5%.

The hike comes one month before the scheduled annual policy review and follows a 75 basis points hike in the cash reserve ratio in January. The rate hike should anchor inflationary expectations and contain inflation going forward, the central bank said. The measure also shows policy makers’ confidence in the momentum of economic recovery. As liquidity in the banking system will remain adequate, credit expansion for sustaining the recovery will not be affected.

While the headline inflation on a year-on-year basis at 9.89% exceeds RBI’s baseline projection of 8.5% for end-March and is within a striking distance of a double-digit score, India’s industrial production gained 16.7% in January following a 17.6% increase in December from a year earlier - the fastest pace in more than a decade. The high inflation was until recently perceived to be on account of supply-side factors. But, the central bank now recognises the rising demand side pressures accentuating and complicating the risk of rising inflation.

It is clear that the focus of monetary policy will now tilt towards containing the inflation and inflationary expectations, rather than worrying about a pre-mature tightening undermining the recovery. The fine print of the RBI statement indicates that the pace of the ‘calibrated exit’ would be accelerated. Please share your views.

• Will there be another 25 basis points hike in April? My expectation is YES followed by a series of hikes.
• What will be the level of the policy rates in one year from now (March 2011)? My hunch is at least 150 basis points above the current level.

EXCEPTIONALLY LOW …….. FOR AN EXTENDED PERIOD ……..

America’s Federal Reserve indicated it would be keeping interest rates at close to zero for the foreseeable future, in order to nurture the economic recovery. While the Fed has declared its optimism that the country’s economy was slowly recovering, it decided to maintain the target federal funds rate at the current level of 0-0.25% in view of a mixed picture of the recovery from recession amidst low rates of resource utilization, subdued inflation trends, and stable inflation expectations.

The Fed is widely expected to maintain the current level of interest rates through 2010. However, more significant will be its moves on withdrawal of the liquidity stimulus programmes running into hundreds of billions of dollars that have been in force since the beginning of the sub-prime crisis – the pace and timing of the unwinding. Also, when it is going to drop the four magic words from its statements – ‘exceptionally low’, ‘extended period’.

BOJ Leaves Rate Unchanged at 0.5 Percent

The Bank of Japan decided Friday to keep a benchmark interest rate unchanged at 0.5 percent, maintaining its ;wait and watch’ policy before moving the rates further up. The bank last changed the benchmark interest rate in February, doubling it from 0.25 percent. That was the first hike since July 2006, when the bank ended five years of near zero interest rates. The low interest rates, to a great extent, helped the word’s second largest economy to come out of a decade of stagnation.

The central bank's decision at the end of a two-day meeting was unanimous. There are expectations that the BOJ would like to wait for more signs of economic strength before tightening policy.

Figures released earlier this week showed that the economy grew at an annual pace of 3.3 percent for the January-March quarter, up from an earlier estimate of 2.4 percent. The nation's unemployment rate has also declined to 3.8 percent in April, the lowest level in nine years.

However, consumer prices have fallen the last three months, raising concerns that Japan might be slipping back into deflation. The core consumer price index edged down 0.1 percent in April, 0.3 percent in March and 0.1 percent in February — which was the first drop in 10 months.

Eurozone rates raised to 4%, UK steady at 5.5%

The European Central Bank (ECB) last week raised interest rates for the eurozone to 4% from 3.75% - taking rates in the area to their highest level in six years.

Though the rate increase was widely expected, what was awaited eagerly was cues on further rate actions. At his news conference, ECB president Jean-Claude Trichet said that eurozone monetary policy is "still on the accommodative side", suggesting that more rate hikes may be in the pipeline.

The eurozone economies, especially Germany, have been growing strongly in 2007, unemployment in the eurozone is at its lowest level since the launch of the euro, while confidence is high and business activity is expanding.

Meanwhile, the Bank of England decided to keep its benchmark rate at 5.5%. Even as the bank freezes the rate and goes in a ‘wait and watch’ mode to assess the impact of the series of recent rate hikes, a rate rise later this year remains likely. UK rates have been increased four times since August last year in an attempt to rein in inflation. But price growth still remains strong. While consumer price index (CPI) inflation fell from 3.1% to 2.8% in April, the measure still remains well above the government's target of 2%.

ECB Expected to Raise Key Rate

The European Central Bank is expected to raise its key interest rate by a quarter of a percentage point to 4 percent when it meets today, taking the borrowing cost in the 13-nation euro zone to its highest level in six years. The corresponding benchmark rate is 5.25 percent in US and 5.50 percent in Britain.

Besides the rate decision today, on which there is a near unanimity, the markets will be looking for clues on future rate moves.

The euro zone economy has been growing at a healthy pace, unemployment is at its lowest level since the launch of the euro while business and consumer confidence are up. ECB has been calling for “strong vigilance" to keep inflation under control – a phrase considered by the market as a signal of continued rate increases, typically a quarter of a percent. Year-on-year inflation in the zone was 1.9 percent in May — unchanged from the previous two months, and around the ECB's guidelines of just under 2 percent. While there are concerns about inflationary risks, the ECB will also have to consider global developments such as the problems in the US housing market and uncertainty about Chinese stock markets.

Bernanke expects economic rebound, dashes rate cut hopes

Federal Reserve Chairman Ben Bernanke has re-iterated his belief that the US economy will bounce back from its sluggish performance so far this year to advance at a “moderate pace” in the coming quarters - close to or slightly below the economy's trend rate of expansion, even if the housing slump persists. The US economy's trend or normal growth rate is put at around 3-3.25 percent. The assertion dashes the prevailing expectations that Fed will start cutting interest rates in order to stimulate growth. A section of the market has been expecting that Fed will be forced to cut interest rates later this year, as the economy struggles to come out of the slowdown.

Economic growth in the year's first three months nearly stalled, logging just a 0.6 percent pace. It was the worst quarterly showing in more than four years. Bernanke said he believes some forces that figured prominently in that poor performance — including a bloated trade deficit, cutbacks by businesses in inventory investment and weak federal defense spending — "seem likely to be at least partially reversed in the near term."

The Fed meets next on June 27-28 and many economists predict policymakers will again hold a key interest rate steady at 5.25 percent, where it has been for a year. Many economists think rates will stay where they are for the rest of this year.

Regarding the housing slump, the US Fed Chairman accepted that it may continue to be a drag on economic growth for longer than previously expected. The saving grace is the housing market's problems haven't spread through the broader economy in a significant way. "We have not seen major spillovers from housing onto other sectors of the economy," he observed.

China Continues Credit Tightening, Raises Reserve Ratio Again

China’s central bank announced another increase of 0.5 percentage point in the reserve ratio effective May 15. Big banks will now be required to hold 11 percent of their deposits in reserve at the central bank. This is the latest in the series of measures the People’s Bank of China has been taking to cool down credit and investment growth - fourth increase in reserve requirements this year and seventh in past one year. Over the past year, the central bank has also raised interest rates three times - most recently on March 17.

The central bank of the word’s fourth largets economy has been struggling to sterilize a surfeit of liquidity largely flowing in from the burgeoning trade surplus and capital inflows. The excessive liquidity has given rise to worries of potential asset price bubbles. In particular, the easy money has been fueling rally in the domestic stock market which is being considered unsustainable. Chinese stocks have risen 40 percent this year on top of a 130 percent leap in 2006.

Rate hikes imminent in UK

Inflation surges, Pound breaches $2


The British pound has moved through the $2 mark for the first time in nearly 15 years after the latest data showed an unexpected surge in inflation, prompting speculation that interest rates would have to be increased to slow inflation. The last time the $2-level was breached was just before sterling dropped out of the Exchange Rate Mechanism in September 1992. Significantly, Euro is also trading at a two-year high against the dollar and a record high versus the Japanese yen.

According to the data released by the government's Office for National Statistics on Tuesday, consumer price inflation increased to 3.1 percent in March, up from 2.8 percent in February - well above the Bank of England's target of 2 percent. The headline rate of retail price inflation, a wider inflation measure, rose to 4.8 percent from 4.6 percent. The rising inflation rate forced the Bank of England governor to write a letter to the government explaining why inflation has climbed and what the central bank proposes to do about it. The letter said that the central bank is “determined” to set interest rates at a level required to bring inflation back to its 2% target.

The central bank has raised its benchmark rate three times by a quarter percentage point each since August last year in an attempt to contain inflationary pressures. At its last rate-setting meeting earlier this month it kept rates at 5.25%. Now in the wake of the continued surge in inflation, it is expected to lift rates in May to 5.5% and possibly beyond.

THE SUSPENCE IS OVER..
BoJ Raises Interest Rate

The Bank of Japan has raised its overnight lending rate to 0.5 percent, saying that prolonging a low-interest-rate policy could hamper economic growth. This has been one of the closest calls for the market as opinion was sharply divided amidst strong fourth quarter growth numbers but lingering doubts on sustainability of the economic recovery.

The central bank of the world's second largest economy said in a statement that the the economy is likely to continue its moderate expansion with a virtuous circle of production, income and spending in place. The statement indicated that future adjustments on interest rates will be gradual.

Here are some major points from the statement--

1. Uncertainties over the future course of overseas economies, including that of the United States, are abating, and this is likely to reinforce the prospects of continued increase in corporate profits and business fixed investment.
   
2. With respect to private consumption, the weakness observed in the last summer seems temporary, and it is judged that private consumption is on a moderate increasing trend.
   
3. Consumer prices (excluding fresh food) have been registering small increases on a year-on-year basis, and it is possible that the rate of change will be around zero in the short run. From a longer-term perspective, however, consumer prices are likely to increase as a trend, since the utilization of resources such as production capacity and labor has been increasing and the economic expansion is expected to continue.

China raises reserve ratio

In a move to temper the staggering pace of economic growth and curb inflationary pressures, China's central bank has raised the reserve ratio by 50 basis points. Commercial banks will now be required to set aside 10% of their deposits in cash reserves. This is the second hike in 2007 and fifth since last July.

The People's Bank of China is concerned that continued growth will stoke consumer prices as the economy marks a record trade surplus. Mounting trade surplus along with strong FDI inflows are adding to the excessive liquidity in the banking system and the central bank has taken a slew of measures to slow the pace of lending.

"Since 2006, the People's Bank of China has used a combination of monetary tools to soak up liquidity in the banking system and has achieved some results," the central bank said in a statement posted on its web site. "But the surplus in international payments remains large and the pressure on loan expansion is still relatively big so it is necessary to again increase the reserve ratio," it said.

China's economy, the world's fourth-largest, expanded 10.7% in 2006. And consumer prices returned a rise of 2.2% for the month of January - lower than the previous month's 2.8%, still high enough to call for continued tightening bias.

ECB holds interest rate, may raise in March

The European Central Bank has decided to keep its key interest rates on hold at 3.5%, waiting to see if its last increase in December can keep inflation at bay and hinting that a hike may come in March. The ECB President Jean-Claude Trichet said "strong vigilance" was needed to avoid "risks to price stability" – a statement being seen by the market as a clear signal for a rate hike next month. The term ‘vigilance’ seems to have acquired a new meaning for the followers of Trichet-speak - each of the last six times Trichet used the word vigilance, a rate increase was handed down the next month.

The key eurozone economies have had a strong start to 2007. Unemployment has fallen in France and Germany, with consumer confidence remaining strong, despite Germany's decision to increase value added tax (VAT) from 16% to 19%. While growth is expected to remain strong, wage pressures are mounting. The latest round of pay negotiations in Germany will be keenly watched. Inflation in the euro zone was 1.9 percent in December for a third straight month, at its recommended level of just under 2 percent.

Meanwhile, Bank of England also held official interest rates steady at 5.25 percent after a surprise increase last month of a quarter of a percentage point.

US hopeful of soft landing

Interest Rates Unchanged

The U.S. Federal Reserve has left interest rates unchanged at 5.25 per cent for the fifth time running. The widely expected move comes amid signs of the US economy staying reasonably strong and inflation being more under control. While recognizing “somewhat firmer economic growth” and “signs of stabilization” in the housing market, the rate-setting Federal Open Market Committee has expressed growing confidence that inflation is running lower. "Readings on core inflation have improved modestly, and inflation pressures seem likely to moderate over time," the central bank said. At the same time, it also repeated its caution that "some inflation risks remain" - a sign that it is likely to keep its benchmark rate at current levels for the near future (or, may even raise further). The US economy grew faster than expected in the last three months of 2006, as increased consumer spending offset a housing market slowdown. The GDP rose at an annual rate of 3.5% from October to December, while the growth rate for 2006 as a whole was 3.4%, more than 2005's 3.2% expansion. The Fed's policy aim is to achieve a “soft landing” - a mild slowdown in growth that would cool down inflationary pressures but not spiral into a recession.

Bank of Japan's assessment of economic & financial developments

The Bank of Japan’s policy board decided, in a 6-3 vote, to keep its benchmark interest rate steady at 0.25 percent, leaving the impression that the central bank has bowed to political pressure to move slowly. The political establishment has expressed concerns that raising rates too quickly will choke off the nascent recovery, as the economy faces weak consumer spending and no clear signs of inflation.

In its Monthly Report of Recent Economic and Financial Developments January 2007 released on 18th January, BoJ has said that the developments have so far deviated slightly downward from the outlook presented in October 2006, mainly due to weaker-than-expected private consumption. Looking ahead, the bank expects that the economy will develop broadly in line with the outlook, as a virtuous circle of production, income, and spending is likely to remain intact. Here's the text of the report.

Japan's economy is expanding moderately.
Exports have continued to increase, while public investment has been on a downtrend. Business fixed investment has continued to increase against the background of high corporate profits. Household income has also continued rising moderately. In this situation, private consumption has been on an increasing trend, although the pace of increase has been only modest. Housing investment has been increasing moderately with some fluctuations. With the rise in demand both at home and abroad, production has also been increasing.

Japan's economy is expected to continue expanding moderately.
Exports are expected to continue rising against the background of the expansion of overseas economies. Domestic private demand is likely to continue increasing against the background of high corporate profits and the moderate rise in household income. In light of these increases in demand both at home and abroad, production is also expected to follow an increasing trend. Public investment, meanwhile, is projected to remain on a downtrend.

On the price front, domestic corporate goods prices have recently been somewhat lower than their levels of three months earlier, due to the drop in international commodity prices. The year-on-year rate of change in consumer prices (excluding fresh food) has been on a positive trend.

Domestic corporate goods prices are expected to be somewhat weak or stay flat in the immediate future, due to the drop in international commodity prices. The year-on-year rate of change in consumer prices is projected to continue to follow a positive trend, as the output gap continues to be positive.

As for the financial environment, the environment for corporate finance is accommodative. The issuing environment for CP and corporate bonds is favorable. Also, the lending attitudes of private banks have continued to be accommodative. Credit demand in the private sector has been increasing. Under these circumstances, the amount outstanding of lending by private banks has been increasing. The amount outstanding of CP and corporate bonds issued is slightly below the previous year's level. Funding costs for firms have risen slightly. Meanwhile, the year-on-year rate of change in the money stock is at the 0.0-1.0 percent level. As for developments in financial markets, in the money markets, the overnight call rate has been at around 0.25 percent, and interest rates on term instruments have been around the same level as last month. In the foreign exchange and capital markets, stock prices have risen compared with last month, while the yen's exchange rate against the U.S. dollar has fallen compared with last month. Meanwhile, long-term interest rates have been around the same level as last month.

Developments in Japan's economy have so far deviated slightly downward from the outlook presented in the Outlook for Economic Activity and Prices (the Outlook Report) released in October 2006, mainly due to weaker-than-expected private consumption caused partly by temporary downward pressure stemming from the unfavorable weather conditions. Looking ahead, however, the economy is expected to develop broadly in line with the outlook, as a virtuous circle of production, income, and spending is likely to remain intact. As for prices, domestic corporate goods prices are expected to deviate slightly downward from the expected trajectory, reflecting the drop in crude oil prices. Consumer prices have so far deviated slightly downward from the projection, partly reflecting the drop in crude oil prices, but they are expected to develop broadly in line with the projection.

The politics and the economics of interest rates

Bank of Japan has decided to keep the borrowing rates unchanged at 0.25 percent, concluding that it is too early to raise rates. Recent signs of slowing growth have prompted worries that Japanese economy could be faltering after five years of slow but steady growth. The central bank of the world’s second largest economy cited weaker-than-expected private consumption and growing downward pressures on domestic prices as the reason for going against an increase. BoJ had raised the level of borrowing rates by a quarter point to 0.25% last July, ending a long period of zero rates and another increase was widely expected as the economy has been doing well. The bank maintains its stance of gradually adjusting interest rate levels based on the economy and prices, though some recent comments by bank officials seemed to favour a rate increase. The decision is also being scrutinised from political angle - for the central bank's ability to maintain independence in its conduct of monetary policy.

Bank of England surprises with rate hike, ECB holds

Monetary policy and central bank actions need not always be boring. Bank of England has delivered an exciting story to the markets, by raising its base rate by another quarter-point to 5.25%. This follows two earlier hikes of same magnitude, as part of an effort to stem inflationary pressures – one in November last and another one in August, the hike in August being similar to the latest one in surprise element.

The European Central Bank, on the other hand, decided to hold rates steady while hinting at an increase later this quarter.

The Bank of England’s move is spurred by worries on creeping inflation which reached 2.7 percent in November — above the bank's target of 2 percent for the seventh month in a row. Given the expectations that inflation may rise further, the BoE's pre-emptive strike looks sensible. What surprised the markets is the timing of the move. It was widely expected that the central bank would wait until February, when it would take stock of the economy as part of its quarterly review of inflation prospects.

The ECB, meanwhile, left its benchmark rate unchanged at 3.5 percent, but President Trichet's comment that it would engage in "very close monitoring" of inflation risks is taken as a signal that a quarter-point hike could be on the cards for March. Annual inflation in the euro zone was at 1.9 percent in December, just below the ECB's target of about or below than 2 percent.

The ECB's forecasts for euro-zone growth this year are between 1.7 percent and 2.7 percent, up from 1.6 percent and 2.6 percent issued last year. For next year, GDP growth is expected to be between 1.8 percent and 2.8 percent. While Trichet said euro-zone inflation is expected to hover at around 2 percent this year and in 2008, analysts expect inflation to rise above the ECB's target early this year and lead to a rate increase in March. The ECB sets policy for 13 nations with more than 316 million people and a combined gross domestic product that accounts for more than 15 percent of the world's economy.

China hikes reserve ratio to cool liquidity growth

In a bid to rein in bank lending and cool liquidity surge in the booming economy, China's central bank has announced another increase in the reserve requirements. The 50 bps hike will be effective from 15th January, bringing the effective rate to 9.5% and follows a series of tightening measures last year - three 50 bps hikes in the reserve ratio and two 27 basis-point hikes in lending rates.

Chinese monetary authorities are worried about the prospects of an overheating in the economy and surging liquidity leading to asset price bubbles. Controlling liquidity has, therefore, been a high priority. The central bank has expressed concerns on various ocassions about the surfeit of liquidity in the system and is expected to follow-on with more rounds of hikes. The "excessive" liquidity in the world's fastest growing economy is building up from large trade surpluses and capital inflows.

RBI hikes cash reserve ratio to tame inflation

Reflecting the persistent worries on inflation amidst ferocious economic growth and surging forex inflows, the Reserve Bank of India has decided to raise the Cash Reserve Ratio (CRR) to 5.50 percent. CRR, a tool used by central banks to control liquidity in the system, refers to the amount of cash (as a percentage of bank deposits) that banks are required to set aside and maintain with the central bank.

Inflation, as measured by rise in wholesale price index, continues to stay near the higher end of the central bank’s target range of 5-5.50 per cent. The economy expanded 9.2 percent in the quarter ended September 30 and foreign investors have been pouring money into Indian stock markets, leading to an overwhelming liquidity surge. The current surplus liquidity in the banking system – reflected in the amounts absorbed by RBI in its daily reverse repo auctions (banks parking excess funds with RBI) – is estimated to be in the range of Rs 25,000-30,000 crore. This is on the back of a strong over 30% growth in bank lending.

“It is necessary to recognize the challenges emanating from capital flows and consequent impact on increasing liquidity”, the RBI statement notes. ``The overall impact on inflation expectations requires to be monitored and moderated.”

The CRR hike will be effected in two phases - from current 5 per cent to 5.25 per cent effective December 23 and to 5.50 per cent from January 6. The move will impound about Rs 13,500 crore of bank funds.

Related posts:

(1) 'Reddy' for another hike?

http://aktonmarkets.blogspot.com/2006/10/reddy-for-another-hike-when-reserve_28.html

(2) RBI hikes repo rate, leaves other rates unchanged

http://aktonmarkets.blogspot.com/2006/10/rbi-hikes-repo-rate-leaves-other-rates.html

Japan interest rates on hold - for now

Japan’s central bank has decided to keep interest rates frozen at 0.25%, as the policymakers take stock of the pace of recovery before taking the rates northward. The decision was widely expected by the market.

Bank of Japan ended its five-year policy of keeping base rates at zero in July this year, in a bid to stimulate growth. Japan's economy grew more strongly than expected in the third quarter, but consumer demand has remained sluggish.

The strong economic growth suggests that rate hike may come as early as next month. The next policy meeting of the central bank is scheduled for December 18-19 and the policy-makers will have more data to make a thorough assessment of economic and price situation. The economy grew at a 2 percent annual rate in the last quarter. The revised third-quarter GDP figures will be published on December 8 and the central bank's quarterly Tankan survey a week later. The most recent Tankan business survey last month showed strong business confidence.

US FOMC minutes hawkish again, inflation eases, Japan rates untouched

US Fed officials maintain a hawkish tone on inflation in the minutes of the last month’s meeting. The Federal Open Market Committee, which decides on interest rates on monetary policy actions, had decided to keep interest rates on hold at its October 24-25 meeting.

This marks a pause for the third time in a row. US interest rates have risen over the past two years as the world's largest economy has recovered and price growth has picked up. The US central bank has kept interest rates steady at 5.25% since August, and is expected to maintain its current stance when it meets next month.

According to the minutes released Wednesday, the Fed noted that reducing inflation to counter expectations of higher prices was its 'greatest concern' and worried that inflation might not recede as hoped and an inflationary psychology could set in, making its job tougher. It assessed that core inflation was still uncomfortably high and that a tight labour market could lead to wage pressures. However, Fed officials also observed that high profit margins may be able to absorb some part of the higherlabour costs. On the housing market, the minutes said that ongoing adjustment was likely to depress real activity in the near term, but thatthis effect was expected to wane gradually.

Meanwhile, consumer prices fell in October for the second month in a row, on the back of cheaper oil. The reading will offer some comfort to the policy-makers when they meet next month. The Labor Department said that prices fell by 0.5% in October, more than many analysts had forecast. The annual inflation rate was 1.3%.

The Bank of Japan (BoJ) voted to keep policy rates steady, as widely expected. Japanese GDP grew 2% annualised for the quarter ended September, twice thatexpected, but the data did not provide sufficient fuel for the BoJ to act this time around.

'Reddy' for another hike?

When the Reserve Bank of India reviews its monetary policy on October 31, will it raise the interest rates once again or will it wait and watch, giving the previous hikes more time to work? The central bank has raised the reverse repo rate three times this year by quarter percentage point each to 6 percent, to curb inflationary expectations stoked by strong economic growth.

The inflation has mostly remained within the RBI's comfort zone of 5-5.50 percent. But of late, it has started edging towards the higher end of the range. The latest data has shown the annual inflation measured by Wholesale Price Index at a four month high. The inflation for the week ended October 14 was at 5.26 percent - up from the previous week's figure of 5.16 percent, on account of higher prices for food, edible oils and textiles. Going ahead, the inflation numbers are expected to return higher readings because of low base effect and may inch up to 6%.

As the strong growth momentum keeps an upward pressure on inflation, RBI may have to do a bit more monetary tightening. Bond markets have been generally sanguine in the past couple of months. Yield on the 10 year benchmark government bond has fallen three quarters of a percentage point after touching an almost five-year high of 8.4 percent in July. This optimism may be misplaced. RBI may go in for a pre-emptive hike now rather than waiting for the next review when inflation may have gone beyond the March-end target of 5-5.50 percent. Even if RBI decides not to change the rates now, the tightening cycle is far from over.

Besides domestic growth considerations and inflationary expectations, RBI will also have to weigh the global scenario – US rates being on hold amid economic slowdown, strong growth and continued tightening bias in Euro-zone economies, sustained expansion in Japan and possible rate actions.