NEWS / Foreign Exchange

Bank of Japan raises reference rate

The Bank of Japan finally decided to raise its interest rates in the third week of February. After confusing the markets in January when nearly all operators were expecting a rise, this time the Japanese monetary authority stopped vacillating and declared an increase of 25 basis points in its reference rate putting it at 0.50%. This was the second upward move since it began its restrictive turn in July 2006. The argument given by the Japanese central bank was the good macroeconomic results in the fourth quarter published a few days beforehand.While it is true that inflation scarcely exists, the monetary authority believes that the economy will continue to grow at a moderate rate. The central bank chose a gradual path for raising its interest rates so that the official rate will probably stay at 0.50% for some months.

The same thing will likely happen in the United States where no changes are expected in coming months. The message given out by the US monetary authority is to maintain the objective of the overnight interbank rate at 5.25%, a level resulting from the balance between the improvement in the economic situation and the problems affecting the real estate market. In his appearance before a Congress committee in midFebruary, Ben Bernanke, chairman of the Federal Reserve, stated that inflation was tending to drop but indicated that the Fed would maintain an upward bias in monetary policy, that is, over the long term they could end up raising the interest rate.

British rates also point to a rise. On February 8, the Monetary Policy Committee of the Bank of England decided to maintain the official interest rate at 5.25%. In contrast to its meeting in January, when the increase in the interest rate caught the markets unprepared, this was no surprise and later on prospects of further increases somewhat cooled off. Nevertheless, as expected by the market, some rise is likely in coming months in order to contain inflationary pressures.

At its meeting in the second week of February, the European Central Bank (ECB) did not modify its reference rate level but left it at 3.50%. Chairman Trichet, however, repeated that the level of interest rates was still low and that monetary policy was easy and pointed to a further rise in reference rates in March. While the rise in crude oil prices in recent years has not had significant passthrough effects, the ECB expressed its concern about the outcome of wage negotiations underway. Given that the European economy seems to keep growing more than expected, it is possible that the rise in March will not be the last in this round.With this rise the reference rate could go to 4%, a point closer to the neutral level.

The institution that did decide to act once more was the central bank of India, that was alarmed by signs of overheating of the economy. At the end of January, among other restraints on monetary policy, it decided to raise the repo rate by 25 basis points to 7.5%. The Indian economy is growing more than expected and the central bank raised its own growth projections for the year ending March 2007 to 8.5%-9%, which increases inflation risks. In addition, in mid- February the Bank of Sweden again raised its reference rate by 25 basis points to 3.25% bringing it close to the euro area level.