NEWS / Foreign Exchange

US Fed, ECB, BoJ

Although both short term and long term rates have started to rise globally following the massive move to risk averse assets over the past few weeks, the direction of the yield curves signal a gloomy picture. Shorter term rates have been given a solid boost by mounting inflation fears, as CPI figures for the month of February have started to rebound on the back of oil costs. For example, this was the case in the US, where the curve for has inverted further, especially as fears of the impact of collapsing subprime lenders resonated through the markets. In Japan, however, both ends of the curve actually edged lower as Bank of Japan Governor Fukui and other officials have made it clear that slow wage growth and near deflationary conditions severely limit the ability of the central bank to raise rates again in the near-term. Overall, this mass movement of yield curves towards inversion points to significantly higher odds of recession.

US Fed ??“ Working to Keep Inflation In Check, But At What Cost?

The FOMC continues to maintain an optimistic tightening bias on the economy and monetary policy:

• Randall Kroszner, Federal Reserve Bank Governor
  ???The Fed and the central banks of many other countries have been successful in holding long-run inflation expectations down. However, bad luck or other factors could cause expectations to begin to drift again. If so, the Federal Reserve will need to respond appropriately.??? ??“ March 13, 2007
  ???Inflation expectations have become well-anchored because the public has become confident the Federal Reserve will do the right thing. But this belief will persist only as long as we on the Federal Open Market Committee continue to ratify the public's expectations that inflation will remain low and stable.??? ??“ March 13, 2007

However, as dismal stories regarding the subprime sector flood the news, former and current officials seem to just be waiting for the ball to drop:

• Alan Greenspan, Former Federal Reserve Chairman
  ???You can't take 10% out of mortgage originations without some impact. I'd expect it to -- I'm waiting -- but the spillovers are just not there.??? ??“ March 16, 2007
  

• Henry Paulson, US Treasury Secretary
  ???You need to look at the underlying economy. We've got in my judgment a healthy economy. The fundamental question is has that market bottomed out? I'm optimistic that it has, I don't know for sure, I think the next couple of months we'll know a lot more than we know now.??? ??“ March 14, 2007
  

• Edward Lazear, US Chairman of the Council of Economic Advisers
  ???The issue that I would focus on is not so much whether it's going to spread - I don't think many people believe it's going to spread - it's simply too small a part of the total economy for it to spread. The issue is whether it's symptomatic of some more general underlying phenomenon that's showing up first in the subprime market. I think the answer to that is probably not.??? ??“ March 20, 2007

ECB ??“ Topped Out At 3.75%?

Two weeks after the European Central Bank??™s March 8 hike to 3.75%, the official stance of the bank has downshifted from ultra-hawkish. Nevertheless, the door is still open for one more rate increase to 4.00% by mid-year:

• Klaus Liebscher, European Central Bank Governing Council Member
  ???We have no pre-commitment on this special issue and we will check and analyze all the data which will come in within the next weeks, months, and then we will see what is necessary to do. But I think there is no doubt that we will try to do everything that is necessary...to keep the inflation expectations where they are, that means within our definition of price stability.??? ??“ March 20, 2007
  ???I warn everyone who says we have inflation under control??¦we absolutely see risks on the horizon??¦ the ECB cannot lean back and consider the job done.??? ??“ March 13, 2007
  

• Erkki Liikanen, European Central Bank Governing Council Member
  ???The policy rate is now 3.75%, and monetary policy continues to be on the accommodative side. The Governing Council will monitor very closely all developments so that risks to price stability over the medium term do not materialize. These risks remain on the upside, relating in particular to stronger than currently expected wage developments.??? ??“ March 20, 2007
  

• Axel Weber, European Central Bank Governing Council Member
  ???The slowing of inflation is temporary. This year inflation will probably fall through late summer in the euro area to possibly around 1.5 percent -- this is not ruled out. Then we see a strong pick up in inflation. It could well surpass 2 percent at the end of 2007 and into 2008.??? ??“ March 16, 2007

Meanwhile, the French are still up in arms as Euro appreciation accelerates:

• Nicolas Sarkozy, French Presidential Candidate
  ???Competition is such with globalization that we don't need to fight inflation like we fought inflation 30 years ago. I want the Europeans to be able to do with the Euro what the Americans do with the US Dollar, the Japanese with the Yen and the Chinese with the Yuan (i.e. use their powers to influence exchange rates). It's the very least??¦We are depriving ourselves of an instrument to create growth, provide jobs, for purely ideological reasons. Well, the Euro doesn't belong to Trichet??¦and I'm not the only one in Europe who thinks so.??? ??“ March 19, 2007

BoJ ??“ Fixed At 0.50% Until Further Notice

While Bank of Japan Governor Fukui works to sooth the fears of a frazzled market amidst the surge in volatility over the past few weeks, officials make it clear that further normalization of monetary policy may not come to fruition until much later in the year:

• Toshihiko Fukui, Bank of Japan Governor
  ???In one word, we understand that the recent development on the global capital markets, including stock markets, are within the scope of a healthy correction. But we will watch closely and objectively developments within the capital markets, to ascertain if these developments will have any impact on the actual economic activity. Overall, we have not observed any change in the economic fundamentals since the last policy board meeting (in February).??? ??“ March 20, 2007 ???There is no change to our policy stance that we will maintain interest rates at extremely low levels for the time being and adjust the level of the policy interest rate gradually, while monitoring closely developments in economic activity and prices.??? ??“ March 20, 2007
  

• Kiyohiko Nishimura, Bank of Japan Board Member
  ???Japan's economy is recovering from a state of convalescence, and it is natural to believe that economic and price conditions will gradually improve. Given that there is a long and variable lag in the effect of monetary policy (on the economy), it is essential to make policy decisions by looking not at the underlying state but at the outlook of the economy.??? ??“ March 13, 2007

• Kazunori Tanaka, Japanese Senior Vice Finance Minister
  ???Basically the economy is going smoothly. Gradually we will clear various problems. If the economy is trending towards an expansion, labor wages are likely to rise. I don't think we are trending towards inflation. Changes in monetary policy may require some time. We are not in the situation of continuously changing rates.??? ??“ March 14, 2007 Hiroko Ota, Japanese Economics Minister ???The economy's recovery trend overall is firm. However, there is no change in the sluggishness in wage growth, which has been a factor behind lackluster consumption since summer, so we need to continue to watch (consumption) carefully.??? ??“ March 13, 2007