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.

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.

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.

War on inflation intensifies - CRR raised again

The Reserve Bank of India has announced another hike in the cash reserve ratio, as inflation continues to surge despite a slew of monetary and fiscal measures taken in the last couple of months. The 50 bps hike takes the CRR - the balance that banks need to maintain with the central bank - to 6% and will be effective in two phases of 25 bps each, first phase kicking in on 17th February and second phase starting 3rd March. The move will impound about Rs. 14,000 crore out of the banks' deposits.

It was on 8th December 2006 that the RBI had last raised CRR by 50 bps, absorbing around Rs 13,500 crore. This was followed by a 25 bps increase in the repo rate on 31st January. RBI is worried about the spiraling inflation and has been taking measures to avoid overheating of the economy as it continues to grow ferociously. See a detailed analysis of the interest rate scenario and RBI's actions here.

The Indian economy is expected to grow at 9.2% in FY2007 on the back of 9% growth last year. The annual wholesale inflation rate has touched 6.58% for the week ended 27th January - a full percentage point higher than RBI’s target for the current fiscal.

Besides the surging inflation numbers, the recent move seems to have been triggered by the rise in liquidity from RBI's intervention in the forex market in the last few days. RBI has been buying dollars to halt the appreciating rupee as a strong domestic currency affects the country's exports.

The CRR hike is bound to have an impact on banks' lending rates, including those on home loans, auto loans and personal loans. In the weeks following the recent repo rate hike, some of the private sector banks have already raised their lending rates. Public sector banks, which constitute three-quarters of India’s banking industry refrained from doing so as they were advised by the finance minister to maintain the current rates, especially on housing loans. They may have to follow suit now, as the liquidity squeeze puts pressure on their cost of funds.

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.

RBI raises repo rate

RBI has raised the short-term repo rate by 25 bps to 7.50 per cent, while keeping reverse repo (6 per cent), bank rate (6 per cent) and CRR (5.50 percent) unchanged.

Concern over surging inflation is the dominant theme of the quarterly review of monetary policy and the hike is on expected lines as the central bank had given enough indications in its macroeconomic review that it is worried about the underlying inflationary pressures. Inflation, which had breached the 6 per cent mark in the first week of January, had eased marginally to 5.95 per cent in the following week ended January 13. The RBI’s year target band for inflation is 5-5.50 per cent. Meanwhile, the Government on its part has taken a series of fiscal measures to rein in the rising inflation.

Repo rate is the rate at which the central bank buys securities to infuse liquidity in the system and reverse repo rate is the rate at which it sucks out excess liquidity by selling securities in the market. The daily repurchase window is expected to provide a ‘corridor’ for the overnight rates, with reverse repo rate and repo rate acting as the floor and the ceiling respectively. By increasing the repo rate while keeping the reverse repo rate unchanged, RBI has widened the spread to 150 bps which has traditionally been maintained at 100 bps. Interbank overnight rates tend to stay near the repo rate in a situation of tight liquidity as prevailing now.

Echoing the all-pervasive bullish outlook on economy, the RBI has revised upwards the GDP growth projection to 8.5 to 9 per cent in 2006-07 as compared to 8 per cent projected in mid-term review and 7.5 to 8 per cent earlier. On inflation, it observed prices of food articles would have considerable impact on headline inflation over the rest of the year. The seasonal decline in prices of food articles in the second half of the year has been less than normal. The prices of manufactures are firming up and were close to the headline level by the end of December.

The central bank has re-iterated its worries on continued high credit growth in the real estate sector, also identifying outstanding credit card receivables, loans and advances qualifying as capital market exposure and personal loans as a matter of concern. It says, there are abiding concerns relating to the persistently high credit growth and the potential for erosion in the quality of credit so that balance sheets of banks need to be fortified against the build-up of loan delinquencies by precautionary provisioning and a greater sensitivity to underlying risks by enhancement of risk weights applied to advances to specific sectors in which banks’ exposures have been rising at a fast pace.

Significantly, RBI has signaled in its statement that more interest rate hikes are on the cards, as the economy continues to grow ferociously and containing inflation takes priority in policy. RBI mentions that early warning signals emanating from rising inflation in an environment of high money and credit growth indicate that monetary policy is still accommodative, warranting a policy response in terms of a measured increase in interest rates to assuage demand pressures. The stance of monetary policy has progressively shifted from an equal emphasis on price stability alongside growth to one of reinforcing price stability with immediate monetary measures.

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.

Turbulence in Indian Money Market – Call Rates Shoot Up

Monetary measures taken by Reserve Bank of India in the recent past in response to the huge credit growth and growing fears of inflation getting out of control, coupled with other seasonal factors like advance tax outflows, have led to a sever liquidity crunch in the Indian banking system. The cash squeeze led the call money rates to shoot up to as high as 20% this Friday.

This is much beyond the ceiling provided by the central bank’s repurchase window and something rarely since the monetary reforms began and the repurchase window was introduced as a mechanism to provide stability in the money market by providing a ‘corridor’ for overnight rates.

Bank credit has been growing at over 30% and the central bank is worried about the inflationary trends. As part of its continuing tightening policy, the RBI announced a two-phase hike in the Cash Reserve Ratio (CRR) earlier this month. CRR is the amount of cash (as a percentage of bank deposits) that banks are required to set aside and maintain with the central bank. The first phase kicked in on last Saturday (December 23) and the second phase will be effective from January 6.

Compared to an estimated surplus of about Rs 25,000-30,000 crore in the beginning of this month, there is a cash shortage of about Rs. 12-15000 crore now. The central bank injected an average of Rs. 12500 crore daily last week through its repurchase window, up from Rs. 4000 crore in the previous week. The repurchase window is expected to provide a ‘corridor’ for the overnight rates, with reverse repo rate and repo rate acting as the floor and the ceiling respectively. Reverse repo rate is the overnight rate at which the central bank sucks out excess liquidity by selling securities in the market and repo rate is the rate at which it injects liquidity into the system by buying securities.

The reason for the rates shooting up much beyond the repo rate of 7.25% is the decline in the bank’s holding of government bonds. With most of the banks’ holding being close to the minimum SLR requirement of 25%, they are not able to borrow from RBI under the repurchase window.

How long will the cash crunch last? It is expected to ease in the coming weeks, as coupon payments, government expenditure and special deposit scheme redemptions will bring back some cash into the system. These may bring the call rates closer to the repo rate of 7.25% - the informal ‘ceiling’ provided by the repurchase window. The days of easy money are, however, over. And, the banks should be ready for occasional bouts of volatility.

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.

RBI hikes repo rate, leaves other rates unchanged

Repo Rate – Increased to 7.25% from 7% Reverse Repo Rate – Unchanged at 6%
Bank Rate – Unchanged at 6.0 % Cash Reserve Ratio – Unchanged at 5 %

In a deft balancing act, the Reserve Bank of India increased the repo rate by 25bps to 7.25 percent, while leaving the reverse repo rate unchanged at 6 percent. Reverse repo rate and repo rate act as the floor and the ceiling providing a ‘corridor’ for the money market. Reverse repo rate is the overnight rate at which the central bank sucks out excess liquidity by selling securities in the market and repo rate is the rate at which it injects liquidity into the system by buying securities. Normally, a 100 bps spread is maintained between the two rates rates, but it has now been increased to 125 bbp. Bank Rate and CRR have also been left unchanged.

The announcement made in the mid-term review of the Annual Policy Statement for FY'07 came as a surprise for the market. Market was expecting a hike in reverse repo rate as well, in view of the pressure on inflation from a strong economic growth. Maintaining optimism about the economic growth, RBI has upped the GDP growth projection for 2006-07 to 8 percent from the earlier 7.5-8 percent. The central bank also maintains the year end (March 2007) inflation target at 5-5.50. Inflation reading for the week ended October 14 stood at 5.26%.