Do we really have to wait until 2009 before a major central bank changes its rates? Probably yes, as the five largest central banks, the Fed, ECB, BoJ, BoE and BoC, all seem to be trapped between rising inflation on the back of high energy and commodity prices, and a real economic outlook that appears to be deteriorating faster than you can spell stagflation. Thus we expect that the key central bank chiefs will meet with the members of their respective monetary policy committees month after month just to decide that current interest rates are probably appropriate for ensuring that inflation expectations do not run amok and that the conditions for economic growth do not become too difficult. Truth be told, no-one knows - with any great degree of certainty - if the current level of interest rates is in fact appropriate, and nor are central banks shy about highlighting the substantial degree of uncertainty that surrounds the forecasts upon which their monetary decisions are based. Only time will tell whether interest rate levels are appropriate.
Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank
Weekly Bank Research Center 08-11-08
On the ECB’s Inflation Objective
Stephen Roach, Head Economist, Morgan Stanley
The inflation objective helps to anchor inflation expectations. This is of special importance at the current juncture as inflation expectations have started to move higher across a range of consumer surveys, forecast polls and financial instruments. Raising the inflation objective right now could cause inflation expectations to become unhinged, sending bond yields much higher. The ECB thus will likely approach the subject with caution and with the determination to fend off political interference. (While the Treaty assigns to the ECB a primary responsibility of maintaining price stability, it remains silent as to the definition of price stability.) But also, an independent central bank like the ECB does not operate in a political vacuum. At the end of the day, the ECB will need the support of public opinion in its pursuit of price stability. To ensure this continuous public support, it will need to deliver price stability as perceived by the public. This is one reason why, at the current juncture, the bank will likely lean towards fighting inflation rather than supporting economic growth – should it be forced to choose between the two.
A Central Bank Chief's Unbearable Lightness of Being
Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank
Do we really have to wait until 2009 before a major central bank changes its rates? Probably yes, as the five largest central banks, the Fed, ECB, BoJ, BoE and BoC, all seem to be trapped between rising inflation on the back of high energy and commodity prices, and a real economic outlook that appears to be deteriorating faster than you can spell stagflation. Thus we expect that the key central bank chiefs will meet with the members of their respective monetary policy committees month after month just to decide that current interest rates are probably appropriate for ensuring that inflation expectations do not run amok and that the conditions for economic growth do not become too difficult. Truth be told, no-one knows - with any great degree of certainty - if the current level of interest rates is in fact appropriate, and nor are central banks shy about highlighting the substantial degree of uncertainty that surrounds the forecasts upon which their monetary decisions are based. Only time will tell whether interest rate levels are appropriate.
Range Bound Rate Outlook Offers No Easy Out for Credit Adjustment
E. Silvia, Ph.D. Chief Economist, Wachovia
There is no easy out for creditors or debtors in our outlook. A difficult workout remains ahead. Short-term rates are likely to remain steady as the Federal Reserve faces the dual imbalance of below-trend economic growth and above-target inflation. For the second half of this year we expect average real growth around 1.5 percent with weakness centered in the domestic economy – consumer and business investment. Meanwhile, inflation, as measured by the core PCE deflator remains at or above the top end of the Federal Reserve’s target range. As for long rates we expect inflation stability will keep the ten-year rate in a tight 3.8 – 4.0 percent range. Yet there is significant uncertainty on both the dollar and federal deficit outlook that suggests that rates could rise above our outlook. On the opposite tack, our concerns about the dollar and further Treasury financing issues are likely to limit any Treasury rallies towards lower rates.
Commodity prices lose steam
Steve Chan, Economist, TD Bank Financial Group
Mounting evidence of slowing or deteriorating growth in major economies has led to a significant pullback in commodity prices. This week, oil prices made headlines as they slipped below the psychological US$120 per barrel level on increased concerns over demand destruction. But it wasn’t just oil – this week saw a slide in the commodity complex as a whole. Natural gas prices slid to a 5-month low, gold prices dropped to US$850, and most base metals prices also lost ground. The drop in commodity prices certainly did not bode well for the Canadian dollar. After reaching parity with the greenback in September 2007 for the first time in over 30 years, and peaking in November, the Canadian dollar has stayed within a tight range of 97 US cents and US$1.03 – until this week. Indeed, the loonie broke through the 97 cent floor on Monday, hovering in the 95 US cent range throughout the week. And after this morning’s employment report, the loonie fell even further, hitting 93 US cents. Given the fact that the Canadian dollar has cracked the floor that has been in place for the past nine months, and that we expect commodity prices to fall by 20% over the next 12 months, there is considerable risk that lower Canadian dollar levels could be in store.
Focus on BoE Inflation Report and CPI Inflation in UK
Trevor Williams, Chief Economist at Lloyds TSB Financial Markets
The BoE's Inflation Report is likely to show continued uncertainty surrounding the trajectory of growth and inflation, as well as continued deterioration in prospects for both compared with May. While we expect the Bank to have softened its view of GDP growth, it may have raised its near-term CPI inflation projections using current market implied rates. With the risk between slower GDP growth and higher inflation remaining fairly equally balanced we maintain our view that base rates will be held at 5% for the remainder of this year. In addition to the QIR, a swathe of UK price-related data are also published. Annual producer price growth exceeded 30% in June, and may be similarly high in July, as oil prices peaked at $147.27 a barrel in the month, therefore, keeping pressure on producers to pass on higher costs. Factory gate price growth may stay around 10% on an annual basis. Headline CPI inflation fears are likely to come to the fore on Tuesday, as the rate of price growth may have surged above 4% from 3.8% in June. RPI inflation could rise from 4.6% to above 5%, while RPIX could hit 5 1/2% from 4.8%, the highest recorded level for RPIX since 1992. Despite the sharp rise in the RPI inflation rate, the benchmark for wage negotiations, 3-month average wage growth is expected to remain subdued at around 3.5%, representing negative real wage growth in relation to RPI and highlighting the downside risk to UK consumer spending over the next few months.
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Compiled by David Song, Currency Analyst for DailyFX.com
