Bernanke, Shirakawa Trail Gjedrem Amid Policy Split

By Simon Kennedy

Oct. 29 (Bloomberg) -- The global monetary policy divide is widening as the Federal Reserve, Bank of Japan and major counterparts lag behind Norway and Australia in raising interest rates, a trend that’s set to continue into 2010.

While Fed Chairman Ben S. Bernanke and BOJ Governor Masaaki Shirakawa may soon unwind some of their emergency measures, JPMorgan Chase & Co. doesn’t expect a Group of Seven member to lift rates before the third quarter. The divergence may boost the currencies of those nations shifting first, with New York University professor Nouriel Roubini warning low U.S. rates may be generating “huge” bubbles as investors borrow dollars to invest in other assets.

“The big boys are going to hold off raising rates for the foreseeable future,” said Jay Bryson, global economist at Wells Fargo Securities LLC in Charlotte, North Carolina. “Their economies have been decimated and are going to take some time to recover even with better global growth.”

The Norges Bank, under Governor Svein Gjedrem, yesterday cited higher-than-expected inflation in pushing its benchmark rate up a quarter point to 1.5 percent and signaling steeper increases than it previously forecast. In August, Bank of Israel Governor Stanley Fischer boosted his benchmark a quarter point to 0.75 percent, while Reserve Bank of Australia Governor Glenn Stevens raised to 3.25 percent from a 49-year low of 3 percent on Oct 6.

Asia Rising

They may soon be joined by other central banks with those in Asia leading the way as their economies power the globe from its recession, fanning inflation and asset gains. South Korea’s economy grew at the fastest pace in seven years in the third quarter, while Indian central bank Governor Duvvuri Subbarao has prepared investors for higher rates by telling banks on Oct. 27 to set aside more cash in government bonds to restrain credit.

By contrast, Reserve Bank of New Zealand Governor Alan Bollard today kept his benchmark rate at a record low of 2.5 percent and said he won’t increase borrowing costs until the second half of 2010 because the nation’s economy needs ongoing stimulus to ensure it emerges from a recession.

Investors will be attracted to the currencies of those economies with rising interest rates, said Mansoor Mohi-uddin, Zurich-based chief currency strategist at UBS AG. He predicts Norway’s krone will outperform the euro, while the Australian dollar will best Canada’s.

Sticking Together

The weak U.S. dollar has hurt earnings at companies such as Airbus SAS that have their costs in the euro, which has gained 12 percent against the U.S. currency in the past six months. Airbus orders are down 80 percent in the first nine months and Chief Operating Officer Fabrice Bregier said on Oct. 8 that “we can only appeal to monetary authorities to ensure currency stability.”

There are risks for both the central banks that act soon and those that delay, said Manoj Pradhan, an economist at Morgan Stanley in London, who likens recent monetary policy to a peloton in cycling in which riders stick together as a group. Those central banks that break away may hurt their economies through rising currencies. Israel has already intervened to weaken the shekel. Those that wait may eventually have to raise rates faster to catch-up, he says.

There is already the threat of bubbles as investors take advantage of low U.S. rates to borrow in dollars and buy higher- yielding assets such as equities and commodities, Roubini said Oct. 27.

“Everybody’s playing the same game and this game is becoming dangerous,” Roubini said. The dollar has dropped 6 percent this year against a basket of six leading currencies.

Hardest Hit

The reason G-7 central banks are lagging behind is that their economies were the hardest hit by the crisis and, even in a recovery, will take time to reclaim lost ground, said David Hensley, an economist at JPMorgan Chase.

The 186-member International Monetary Fund doesn’t expect the G-7’s output gap, which measures the excess of supply versus demand, to be in balance before 2014. That’s helping control inflation, with the Washington-based lender predicting consumer prices in the G-7 will fall an average of 0.1 percent this year and inflation will stay below 2 percent for at least the next five years.

“There’s a lot of slack,” said New-York based Hensley. “There is no way we can see the major central banks hiking for a while.”

Retreating Prices

While the Fed has already announced a phase-out of some of its emergency programs, such as its term auction facility, it has retained a commitment to keep rates near zero for an “extended period.” At the BOJ, policy makers are debating ending their purchases of corporate debt, yet will probably forecast in a report tomorrow that deflation will extend into fiscal 2011, indicating no sign they’ll boost their 0.1 percent benchmark.

European Central Bank President Jean-Claude Trichet and colleagues say declining consumer prices mean there is no rush to raise the record low 1 percent benchmark rate. Bank of Canada Governor Mark Carney says his key rate is likely to be unchanged from 0.25 percent through June. At the Bank of England, where the rate is a record low of 0.5 percent, Governor Mervyn King may extend the bank’s bond purchase plan after the U.K. economy unexpectedly contracted in the third quarter.

The status quo is likely to last into 2010 and perhaps even beyond for some central banks. JPMorgan Chase economists predict the Bank of England will be the only G-7 member to raise its main interest rate next year, starting in the third quarter.

“Exiting too early could abort the present nascent recovery and push economies and financial markets back into crisis,” said Deutsche Bank AG economists Thomas Mayer and Peter Hooper in an Oct. 21 report.

To contact the reporter on this story: Simon Kennedy in Paris at skennedy4@bloomberg.net