Global rate rises: different dynamics, but same effects
Bill Jamieson, The Business, Mar 12
IN New York and in Frankfurt, financial markets are feeling the icy breeze of dearer money FROM `en_central` banks. More interest rate rises look certain in the US and Europe this summer. But easily stealing the interest rate show last week was the Bank of Japan, with its momentous decision to abandon its policy of “quantitative easing”.
It’s easy to see all this as beautifully co-ordinated – like an exercise in synchronised swimming by the world’s top central bankers. But in fact, while the world economy continues to show great strength, with the US, as one commentator puts it, “insolently robust” this is no grand co-ordinated strategy of the type mounted by the Group of Seven to turn down the global money taps.
The circumstances, arguments and dynamics are markedly different in each case. That is why Wall Street experienced some sharp falls this week as opinion hardened on the prospects for more rate hikes, why emerging markets also reacted badly, but in Japan the market greeted the decision to signal an upward move in rates with a 2.6% jump in the Nikkei.
Seldom before has a move by a central bank to tighten monetary policy been greeted with such a surge of enthusiasm. But Japan has been wrestling for more than a decade with falling prices and a lacklustre economic performance. Here was confirmation of a turnround of the year-on-year rate of change on the core Consumer Price Index into positive territory and most of all, that the economy is growing solidly.
The positions of the US and the euro zone could not be more different. The US Federal Reserve has already raised its key money rates 14 times, taking them to 4.5%. There is now little doubt that the Federal Open Markets Committee, under the guidance of its new chairman Ben Bernanke, will raise rates by another 25 basis points to 4.75%. Indeed, the debate is not about whether US rates will be raised again but how much more this rate-hiking is likely to go. Those who have been confidently predicting a procession to 5% and above have been bolstered by continuing evidence of the strength of the US economy despite long and earnest predictions of a slowdown.
Figures last Friday showed US non-farm employment rose sharply last month by 243,000, well above market expectations of 210,000 and the biggest increase in three months – all this despite those 14 interest rate rises. Job gains were fairly broad based and suggested the jobs climate is gaining, not losing, momentum.
The unemployment rate inched up to 4.8% FROM `en_a` four and a half year low of 4.7% in January. The bump-up in the jobless rate came as people – feeling better about job prospects – applied for work in droves.
The robust figures helped the US dollar to hit fresh 2006 highs against a basket of major currencies. Greg Anderson, director of foreign exchange strategy with ABN AMRO in Chicago, said: “The payrolls report took a lot of risk aversion out of the market so people are going back into their favourite trades and one of them is long dollars.”
Predictably, US Treasury debt prices fell as the figures reinforced expectations of at least two more quarter-point interest rate hikes by the Fed. Indeed, the upside surprise was enough to fuel speculation of a third rate hike that would take official short-term interest rates to 5.25% by late June. Altogether less expected was a rally on Wall Street, based on an assessment that the economy could continue to expand even as interest rates were raised.
Across in Europe the situation looks completely different. The rise in interest rates in the first week of March was the second in four months and brought loud protests FROM `en_politicians`. True, there is some evidence of a nascent recovery, particularly in Germany, where the Ifo Index – the country’s most widely followed economic indicator – in February rose to its highest since 1991 when re-unification euphoria brought a confidence boom. But there have been nascent recoveries before, and they have failed to flower into real and sustained growth over the long-term trend rate. Economic growth in the euro zone countries has averaged just 1.3% in the lifetime of the currency. Particularly disappointing has been the performance in the so-called “core” economies of Germany, France and Italy. Unemployment has averaged 8.7% across the single currency zone since the euro made its debut. For all the claims that euro zone membership would bring benefits of superior growth through stability and the greater intellectual rigour of the European Central Bank’s (ECB’s) policy decisions, the case for this is hard to prove. Countries outside the euro zone bloc have done better. For example, the UK has enjoyed economic growth of 2.5% over the seven years that the euro has been in existence, with unemployment kept down to 5% and inflation at 2.2%. Sweden has enjoyed economic growth of 2.7%, more than double the rate of the euro zone average and unemployment has been running at less than two thirds of the euro zone average.
Interest rates are being raised in the
euro zone, not because the single currency economies are going like a train, but because of the ECB’s concern with inflation and in particular with the second round effects of higher oil prices. Some predict the ECB could take rates up to 3.5% next year. Political critics of the ECB point to the relatively tight monetary policy that the bank has pursued over the lifetime of the single currency. It has been tighter than in the US. But it is also true that the euro zone economies have laboured under high taxes and a stifling enterprise climate.
Robert Dun, professor of economics at George Washington University, argues that the ECB’s tighter-than-desired stance has led to a much more modest rate of fixed capital formation – 3.5% over the period 2001-04 compared with a rise of 6% for non-member countries Sweden, Denmark and the UK. He also argues that the ECB’s lack of transparency relative to the US Fed, which publishes both minutes of its meetings and records of its votes, makes for a harder stance.
In Japan the background of the Bank of Japan’s move towards monetary tightening could scarcely be more different. The belief that deflation is on the way out continues to be validated by good economic data. The end of “quantitative easing” (pumping liquidity into the banking system) is the first step of a cautious policy shift away FROM `en_zero` interest rates. It may not be until the end of the year that we see an initial 25 basis points increase in the key rate.
Three quite different economic and interest rate dynamics – but all pointing in the same direction, and with the danger of an effect greater than the sum of its parts: a compounded monetary tightening and a stronger than banked for downturn in activity. Economies across the world could be in for a bumpy ride