Global: Coordinated Central Bank Action

Daily Forex Fundamentals | Written by Danske Bank | Oct 08 08 14:18 GMT |

Overview: Today at 13:00 the Federal Reserve, the European Central Bank, Bank of England, the Swiss National Bank, Riksbanken in Sweden and Bank of Canada in a coordinated action cut key policy rates by 50bp. The People's Bank of China lowered the lending rate by 27bp. The Bank of Japan did not participate in the coordinated action but said it would stay in close contact with other central banks. The coordinated action is a strong signal that the central banks are now working together to fight the financial crisis and support the global economy. We expect further rate cuts from all participating central banks over the coming year as they work to fight the economic downturn. Should the crisis continue, we could see further coordinated action as the global authorities are committed to fight the crisis with all means.

Details: In a press comment the ECB argues for a coordinated rate cut by stating that "the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability. Some easing of global monetary conditions is therefore warranted". We expect the ECB to cut rates further from here as the economy continues to look weak. Furthermore inflation and inflation expectations are coming down. This gives the ECB room to manoeuvre. We are looking for the ECB to cut rates in December 2008 and again in February and April 2009, each time by 25bp, meaning that the ECB policy rate will be 3.00% by summer 2009.

The Federal Reserve delivered the rate cut indicated by Bernanke in his speech yesterday (see Flash Comment - FOMC: Positioning for rate cuts). The decision was unanimous and the FOMC statement made it clear that the rate cut was done as a reaction to a weaker growth outlook on the back of the intensification in the financial crisis. The FOMC stated that "the intensification of financial turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit" and the FOMC is now much less concerned by inflation pressures stating that "the decline in energy and other commodity prices and the weaker prospects for economic activity have reduced the upside to inflation". In our view the Fed remains on an easing bias. We expect a 25bp rate cut at the October 29 meeting and an additional 25bp cut at the December 16 meeting, taking the Fed funds rate to 1.00% by the end of 2008.

In UK the Bank of England stated that "during the past month, the balance of those risks to inflation in the medium term has shifted decisively to the downside". In the light of that outlook, the Committee judged at its October meeting that an immediate reduction in Bank Rate of 0.5 percentage points to 4.5% was necessary to meet the 2% target for CPI inflation in the medium term. With the economy weakening further and inflation coming down, we see the Bank of England continuing with a 25bp rate at each of the coming six meetings (November-April). This will take the Bank Rate to 3.0% - the same level that ECB is expected to reach.

The People's Bank of China (PBOC) today cut both the benchmark lending and deposit rates by 27bp to 6.93% and 3.87%, respectively. The reserve requirement was cut by 0.5ppt. PBOC will continue to cut its lending rate and reserve requirement. More importantly we expect PBOC to abolish bank credit quotas before year-end and possibly start to ease fiscal policy in 2009.

While Bank of Japan (BoJ) welcomed the coordinated effort to cut rate, it chose to remain on the sidelines and leave its leading O/N target rate unchanged at 0.5% using the usual BoJ argument that monetary policy is already very accommodative. In addition BoJ states that Japan's financial markets have been stable in comparison with those in other industrialised markets. BoJ's decision not to be part of the coordinated rate cuts confirm our view that BoJ will be on hold for the next year. Taking part in a coordinated rate cut was in our opinion the only real possibility for a rate cut in Japan in the short run and this door has now finally been closed. From a domestic viewpoint, cutting rates will not make much of a difference and the responsibility for stimulating the economy has increasingly been left to fiscal policy.

The 50bp rate cut from the Riksbank brought the Swedish repo rate down to 4.25%, which is the same level as in June. Apart from financial distress, the Riksbank rate cut was motivated by a significant deterioration in economic prospects for the economy and a waning inflation rate. The Riksbank's forecasts for inflation and growth will be revised downwards. The labour market is weakening and commodity prices have declined substantially. The next scheduled rate meeting will take place on October22, at which time we will also see the third Monetary Policy Report of the year with a new rate path forecast. It is worth reminding ourselves of the fact that in July the Riksbank laid out an alternative rate path in the event of lower inflation driven by commodity prices that saw the Swedish repo rate at 3.50% by Q1 09. Since then the inflation outlook seems even more subdued than in the low inflation scenario, and economic growth seems to be weaker. Consequently, we would not be surprised to see further rate cuts - perhaps as early as at the next meeting in two weeks' time.

The action comes just one day after the Danish Central Bank chose to raise the policy rate to defend the DKK. Following today's action the Danish Central Bank has stated that it will keep the interest rate unchanged for now. But we expect the Danish Central Bank to start narrowing the spread within the forthcoming weeks.

Norges Bank did not participate in the coordinated action but has moved its regular meeting forward by two weeks to October 15. Hence, it seems quite obvious that Norges Bank will follow suit and cut by 50bp at this meeting. Norges Bank said today that the financial crisis had spread rapidly across borders. It might be that Norges Bank was not asked today by the major central banks and that is the reason it did not take part.

Assessment & Outlook: The global central banks and governments are showing very strong commitment to fighting the global financial and economic crisis. The damage to the global economy is growing day by day and this was too much for the central banks to ignore. The fact that the rate cuts are coordinated is a strong signal as it shows that the global leaders are working together to fight this crisis. We believe global authorities will continue to work together in fighting this crisis and do whatever is necessary to turn the financial crisis. Equity markets responded positively with European markets rising 4%; bond yields also rose as money flew from bonds into risky assets.

Danske Bank
http://www.danskebank.com/danskeresearch

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