Monday, May 12, 2003
The dollar once again was pummeled by foreign exchange traders, in part because of non-action by a slew of central banks that met last week. With the risk factor receding in the decision-making process, investors are on the prowl for more lucrative returns on their investments. These opportunities are found in higher interest rate environments such as Europe and South America. Despite less-than-optimistic economic data, investors pushed equities higher. Only three of the 13 indexes followed here declined on the week. The Australian All Ordinaries were down 0.4 percent, the Frankfurt DAX slipped 1.0 percent and the Mexican Bolsa lost 1.6 percent. The remaining indexes increased anywhere from 0.2 percent (Paris CAC) to 3.6 percent (South Korean Kospi). All Asian indexes remain below their 2002 close while all the remaining indexes in Europe (except the CAC), Britain and the Americas are above year-end levels.
Fiddling while Rome burns?
Four central banks met last week and all four left policymaking interest rates unchanged. The Reserve Bank of Australia, Federal Reserve, Bank of England and European Central Bank declined to lower interest rates despite worldwide anemic economic growth in some places and sinking growth in others.
Reserve Bank of Australia as expected left their key interest rate at 4.75 percent. Together with the Bank of Canada, they are the only major central banks to raise interest rates during the past year. Growth is showing signs of weakening thanks to the SARS epidemic in Asia, which has cut exports to places like Hong Kong and travel everywhere. However, Australian employment remains strong, except in the vulnerable tourism and travel sectors.
The Federal Reserve also left interest rates unchanged, at 1.25 percent. Only Japan and Switzerland have lower official rates. Switzerland has cut interest rates primarily because of anemic economic performance stemming from weak EMU growth. But it has also cut rates in a desire to weaken the Swiss franc, which strengthened on the pre-war flight to safety. Japan, which has a zero interest rate policy (ZIRP), has been struggling for 12 years in an attempt to end deflation and get its economy back on track. After the FOMC meeting, the Fed said the balance of risks were weighted towards economic weakness in the near term even though the "ebbing of geopolitical tensions" bolstered consumer confidence as well as the equity and debt markets. It also said it was concerned about disinflation, rather than inflation.
The Bank of England Monetary Policy Committee also did not change its key interest rate from its current 3.75 percent level. Analysts attribute this to inflation fears - their key inflation measure has been above the 2.5 percent target for the last five months. Also, with the pound sterling weakening especially against the euro, inflation could heat up. The currency depreciation adds to inflation via higher import costs and indirectly via the higher growth associated with weaker sterling. As usual, the Bank did not issue any statement at the meeting's conclusion. Instead, Bank of England watchers have to wait two weeks for the meeting's minutes.
Although the ECB left its policymaking interest rate at 2.5 percent, it did ease its policy of trying to restrict inflation to 2 percent. This means that the Bank may act more quickly to cut interest rates to buoy an economy that is on the brink of recession. This was the first time that the Bank had reviewed its monetary strategy since its inception five years ago. With the economy at a standstill and unemployment rising, ECB President Wim Duisenberg said the central bank would now aim for inflation close to 2 percent and is on guard against deflation.
The ECB has cut rates six times since the start of 2001, half as often as the U.S. Federal Reserve, and has drawn criticism from politicians, including German Chancellor Gerhard Schroeder, and major corporations for letting growth slide. The ECB's mandate differs from the mandate of the U.S. Federal Reserve, which is also charged with promoting employment. Rather, the ECB inherited its legacy from the Bundesbank. It sets its own inflation target, unlike the 2.5 percent target set for the Bank of England by the British government. The Bank also demoted its criteria for money supply (a measure of cash and short-term bank deposits) that its uses as a guide to future inflation. Money-supply growth has topped the bank's 4.5 percent reference value significantly for the past 22 months.
Duisenberg said that the euro's rising value is not yet a concern, although the Bank will continue to monitor its volatility. He thought that the current value better reflects fundamentals. He noted that the speed in the rise of the euro has been "almost equal" to the speed at which the currency fell soon after it was launched.
Next time could be different
