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Monday April 21, 2008 - 17:36:25 GMT
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Central Bank Watch: Focus on BOC Rate Decision; Fed Speakers Say Mon Pol Has Limits

12:50 04/21 (CEP News) – The focus this week will shift back to the Bank of Canada when it announces its interest rate decision on Tuesday. Overnight indexed swaps are now 95% priced in for a 50 basis point cut. In the U.S., there were several Fed speakers who said there are limits to what monetary policy can accomplish.

CORRECTION: In a previously posted version of this article, the implied probability of a 50 basis point rate cut from the Federal Reserve was incorrectly listed. Fed fund futures are priced in for a 94% chance of a 25bp cut on April 30, 6% chance of a hold and no chance of a 50 bp cut. CEP News regrets the error.

U.S. Federal Reserve

Current Rate: 2.25%
Next Rate Decision: April 30
Expectation: 94% chance of a 25bp cut (Fed fund futures)

Last week was a busy one for Federal Reserve speakers, who covered everything from monetary policy and economic outlook to the importance of financial education and the need for the Fed to have greater authority over discount window borrowers. As well, two Fed members cautioned that there are limits to what monetary policy can accomplish.

On April 18, Philadelphia Fed President Charles Plosser warned against expecting more from monetary policy than the Federal Reserve can deliver. Plosser said he foresees markets resolving the current problems on their own over time, and repeated that the target rate is low enough to support growth. He noted that the public perception of what monetary policy is capable of achieving has risen “considerably” over the years.

Along the same lines, Federal Reserve Governor Kevin Warsh (voter) said rate cuts and liquidity injections are working to partially offset the impact of the current market turmoil, but cautioned that there are limits to what the Fed’s monetary policy can accomplish and that a full recovery is unlikely to be “swift or smooth.” Speaking at the Global Economic Forum in New York City, Warsh said an indication that market function has returned will be when the Fed’s supply of liquidity is replaced by private liquidity.

Richmond Fed President Jeffrey Lacker said he expects the U.S. economy to contract in the first half of 2008 and that he views inflation as being too high and a problem. He also said he is "uncomfortable" waiting for a slowdown to dampen inflation, as he is not convinced inflation will moderate. Lacker declined to say if he would have dissented on the rate vote had he still been a voting member.

Speaking at a credit conference in Charlotte, North Carolina on April 18, Boston Fed President Eric Rosengren said the Fed needs more authority over firms that borrow from the discount window. “For a central bank to play an effective role during financial turmoil, it needs to understand the sources of liquidity problems, the interrelationships between market participants, likely losses, and market participants’ potential reactions to these losses," he said.

On April 17, Dallas Fed President Richard Fisher, one of two Fed dissenters in the last FOMC rate cut decision, said he has a “strong reluctance” about further rate cuts. Fisher warned against "inflating our way" out of the credit crisis and that further cuts may "compound the bad." In a question and answer session, Fisher said he wants to stabilize the economy but not by opening the monetary policy valve. He also said that the Fed must provide a “bridge” with liquidity measures as opposed to just rate cuts.

Bank of Canada

Current Rate: 3.50%
Next Rate Decision: April 22
Expectation: 95% chance of a 50bp cut (OIS)

The Bank of Canada is the next major world central bank to deliver its rate decision. Markets are now overwhelmingly expecting the BOC to cut its key lending rate by 50 basis points when it meets on Tuesday.

According to Mark Frey, head trader at Custom House, traders are anticipating some aggressive decisions from the BOC in coming months. “The six month USDCAD forward points have declined 14 basis points in the last three sessions while the one year points have narrowed 26 basis points in the last four sessions,” he noted. “In short, the market is now beginning to think that Mark Carney is going to be very aggressive in providing monetary accommodation in relation to the U.S. Federal Reserve, a fact that is weighing on USD-CAD interest rate spreads and drastically altering the forward curve."

The bank now has some breathing room for additional cuts following rather benign Canadian CPI inflation data for March. Both the headline and core rates of inflation came in firmly below the Bank of Canada’s 2.00% target.

Going against the market consensus, however, was the CD Howe Institute’s shadow Monetary Policy Council, which on April 17 voted that the BOC should tread cautiously at its next monetary policy meeting and cut rates 25 basis points. The council notes that there were sharp differences among members about the appropriate setting for the overnight target rate, which currently sits at 3.50%. Seven of the 10 members argue for a reduction, two say the central bank should hold the course and one recommends an increase.

On April 16, BOC Governor Mark Carney said Canada’s economy could suffer from a marked decline in commodity prices, but noted he is also taking into consideration the economy’s strengths when setting monetary policy. Speaking in an interview with the Business News Network, Carney said, “There's a variety of strengths in this economy. So we think about terms of trade, commodity prices and other aspects. We also think about the diversity of our economy and we obviously think about relative strength in our largest trade partners.”

Responding to a question about some forecasts for a drop in commodity prices by as much as 20% to 30%, Carney said, “when commodity prices slow they tend to slow fairly markedly, and the order of magnitude you mention is not unreasonable."

During the G7 meetings in Washington, D.C. earlier this month, Carney said Canada had been spared the worst of the financial market turmoil, thanks to its solid economic foundation. Canada’s situation is not by chance, he said. “It’s because of some very strong fundamentals in our financial system.”

On the morning of April 17, the Bank of Canada conducted another C$2.0 billion 28-day purchase and resale agreement (PRA) in an effort to "support the efficient functioning of financial markets," drawing an average yield of 3.091%. The last such operation took place on April 3, when an identical operation drew an average yield of 3.35%. The high yield was 3.15% while the low yield was 3.06%.

Earlier in the week, Former Quebec Premier Daniel Johnson was named to the BOC’s board of directors after being appointed by Finance Minister Jim Flaherty.

Reserve Bank of Australia

Current Rate: 7.25%
Next Rate Decision: May 6
Expectation: Hold, 12% chance of a 25 bp hike

In the minutes from its April 1 monetary policy meeting, the Reserve Bank of Australia acknowledged it expects inflation to remain high in the short term but that recent tightening by the central bank has helped cool the nation's economy. The minutes also showed that wage growth was "reasonably contained" even though there were no signs of the labour market slowing.

Earlier last week, RBA Governor Glenn Stevens said inflation in Australia is a problem in the midst of being solved. "Inflation is rising. It's a problem and needs to be dealt with," Stevens said at the Australian National University in Canberra on April 14. "And the policies in place will succeed in bringing it back down over time. It will work." He added that it is important for the public to have confidence in the bank’s commitment to containing inflation.

European Central Bank

Current Rate: 4.00%
Next Rate Decision: May 8
Expectation: Hold, 3% chance of 25 bp cut (EONIA curve)

ECB Executive Board member Klaus Liebscher said that 3.6% inflation is cause for concern and saw no room for rate cuts, but that rate hikes were not out of the question. “Without doubt this 3.6% is a very, very worrying development and we must assume that we will have a relatively high inflation rate, too high in my opinion for some months to come and that we will only depart from this level in the final months of this year,” Liebscher said in an interview with Reuters. Suggesting the 2008 inflation would likely average close to 3.0%, Liebscher added that the ECB makes decisions based on recent data.

In its monthly report published April 18, the Bank of Portugal said that the European Central Bank was focused on price stability in the medium term. “Keeping long-term inflation expectations firmly anchored is the biggest priority,” the Portuguese central bank added regarding the ECB in its report.

Earlier in the week, Bundesbank President Axel Weber said that the European Central Bank will act to ensure price stability and that while the strong euro has helped dampen inflation, he saw rising global inflation pressures. Weber, also a member of the European Central Bank’s Governing Council, said that the worst of the market turmoil could be behind us and warned against exaggerating pessimism on the growth outlook.

Bank of England

Current Rate: 5.00%
Next Rate Decision: May 8
Expectation: Hold, 22% chance of 25bp cut (SONIA curve)

Charles Bean, the BOE’s chief economist and member of its rate-setting Monetary Policy Committee (MPC), said April 17 that the UK central bank faces some tricky decisions in the months ahead as it faces a UK housing slowdown, heightened short-term inflationary pressures and an "especially uncertain economic outlook."

He said the MPC has more than just the credit crunch to contend with as the UK's economic outlook remains "especially uncertain" and the committee is "walking a tightrope.” He noted the bank widened the range of collateral accepted in the three-month repurchase operations.

Looking ahead, Bean said the UK’s growth slowdown had been "relatively modest so far." However, the BOE chief economist thinks it will likely weaken through the year as the credit crunch and pressures on real income manifest themselves fully.

On April 16, BOE Deputy Governor John Gieve said the bank will continue pursuing means of liquidity easing and that the goal is to get the mortgage market back on track.

Bank of Japan

Current Rate: 0.50%
Next Rate Decision: April 30
Expectation: Hold, 3% chance of 25% hike (OIS)

Bank of Japan minutes released earlier last week show the bank’s monetary policy committee members agreed to keep interest rates unchanged even with economic growth projected to hit a plateau as risk factors became increasingly apparent both at home and abroad. The nine members reiterated the need to closely monitor increased downside risks in Japan as a result of the intensifying slowdown in the U.S. They also renewed their commitment to monitoring the downside risks to Japan due to the surge in commodity prices.

At the G7 meeting held a week ago, newly-appointed BOJ governor Masaaki Shirakawa said that while the financial market turmoil is ongoing, there is little indication the crisis has had significant effects on the real economy.

On April 18, Shirakawa promised to make the appropriate monetary policy decisions to address global economic expectations for the economy to slow in the near term. Nevertheless, he expects Japan to return to a moderate rate of economic expansion.

By Stephen Huebl, [email protected], edited by Nancy Girgis, [email protected] and Cristina Markham, [email protected]

(END) ©CEP Newswires - ©CEP News Ltd. 2008. All Rights Reserved.

Related recent stories:
(12:31 04/21) North American Summit to Focus on Trade, Security
(12:14 04/21) Upward Risks to Prices Prevalent in Medium Term, Says ECB’s Weber
(11:58 04/21) Canada in Position to Post Deficit, Says Ratings Agency


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