Central Banks May Stay Course, Undaunted by Markets (Update2) June 9 (Bloomberg) -- The world's central bankers are likely to keep raising interest rates to snuff out faster inflation, undeterred by the turbulence their words and actions are having on global financial markets.
``They shouldn't be happy, but they have a job to do, which is keep their eye on inflation,'' said Harvard University Professor Martin Feldstein, once a candidate to succeed Alan Greenspan as Federal Reserve chairman, a job that went to Ben S. Bernanke.
The risk for Bernanke, European Central Bank President Jean-Claude Trichet and their counterparts from South Korea to South Africa is that they raise interest rates too far and quash economic growth. The last time central bankers moved together to tighten credit was in 2000, the year before recessions in the U.S., Germany and Japan.
The ECB, Bank of Korea, Reserve Bank of India and South African Reserve Bank all raised rates yesterday, sending Asian stocks to the biggest slide in two years and pushing Europe's Dow Jones Stoxx 600 Index to its low for the year. Prices for zinc, copper and aluminum weakened, while bonds rose. The Dow Jones Industrial Average rose 0.1 percent yesterday after losing as much as 1.6 percent.
``The contentious bit is the old one about whether central banks should pay particular attention to asset prices,'' said Christopher Allsopp, who teaches economics at Oxford University and is a former Bank of England policy maker. ``They take them into account and they react quickly, but they shouldn't divert from their overall remit of inflation-targeting.''
Bernanke Comments
Bernanke, who had been criticized for not tackling inflation aggressively enough, kicked the week off by telling a banking conference in Washington on June 5 that price increases were too fast for his comfort. Traders judged a quarter-point increase in the Fed's rate this month to 5.25 percent to be almost a done deal after the remarks. The Fed's tightening cycle, the longest in a generation, began in June 2004.
Central bankers are particularly keen not to let inflation expectations gather momentum. That's important because if companies and workers believe inflation is headed higher, their actions may help bring that result. Companies will raise prices, while workers will demand higher wages.
``The big policy blunders have been associated with the failure of central banks to keep inflation expectations under control,'' said Mark Gertler, head of New York University's economics department, who wrote a series of papers with Bernanke when the chairman was a professor at Princeton University. ``That is where the current Fed is coming from.''
Trichet signaled he isn't swayed by the market slide and said further rate rises are warranted. He told reporters in Madrid that the stock-market drop is ``a normal correction phenomenon'' after ``a long period of very low volatility.''
Sanguine BOJ
Bank of Japan policy makers, who are considering lifting their rate from zero, the first move in more than five years, may be similarly undeterred.
``The moves of markets aren't being caused by changing fundamentals of economies,'' Deputy Governor Kazumasa Iwata said at a news conference in Akita, Japan, yesterday. ``They are moving because investors are adjusting their positions.''
An extended period of easy credit around the world encouraged investors to take greater risks, said Louis Crandall, chief economist at Jersey City, New Jersey-based Wrightson ICAP LLC. With that era coming to an end, the markets are adjusting.
``To a large extent what we're seeing is a normalization of risk premiums rather than a loss of confidence,'' said Crandall, whose company is a unit of ICAP Plc, the world's largest inter- dealer broker.
Reddy Moves
Emerging markets have led global declines in equities in the past month as the prospect of higher rates led investors to favor safer assets. MSCI's emerging-markets index, tracking 25 markets, has fallen 21 percent from an all-time high on May 8.
India's Sensitive Index has slumped by a quarter in the past month, leading declines in Asia. Central Bank Governor Yaga Venugopal Reddy yesterday raised rates six weeks before the bank's next scheduled monetary policy statement. Reddy has now increased borrowing costs five times since October 2004.
In Australia, the number of economists predicting an interest rate increase this year climbed after a report yesterday showed the unemployment rate hit a 30-year low in May.
`On a Stretcher'
The central banks are tightening in response to a global economic expansion that's stoking inflation. According to the International Monetary Fund, the world economy is on course to grow 4.9 percent this year, capping the strongest three-year stretch since the early 1970s.
Such growth is straining resources, allowing companies including U.S. chemical maker DuPont Co., Germany's Deutsche Lufthansa AG and China's Baoshan Iron & Steel Co. to raise prices.
Barclays Capital calculates that worldwide inflation is at a 10-year high, with the global gross domestic product deflator running at an annual rate of 2.4 percent in the first quarter, up from 2 percent last year.
``I have found the recent inflation data somewhat troubling,'' Fed Governor Donald Kohn told the Senate Banking Committee in Washington yesterday at a hearing on his nomination to the vice chairman of the central bank.
The tough talk from Bernanke and his colleagues is making some investors nervous. Gold has dropped 16 percent from a 26- year high of $730.40 an ounce on May 12, copper is down 17 percent from an all-time high, and aluminum has also retreated from a record. Yields on U.S. 10-year Treasury notes yesterday fell below those of two-year securities for the first time since March as investors sought a haven from falling stock and commodity markets.
Counting on Success
``The markets are telling the Fed that it risks going too far,'' said Jason Trennert, chief investment strategist at ISI Group in New York. ``The chances of a financial player being carried out on a stretcher have gone up dramatically.''
The tightening of monetary screws is having its desired effect on inflation expectations. The gap between yields on 10- year Treasury notes and comparable inflation-linked government debt narrowed to 2.5 percentage points yesterday, from 2.7 points on May 12. The difference reflects investors' expectations for what inflation will average over the next decade.
Bernanke and his fellow central bankers are betting that they can succeed in capping inflationary pressures without unduly hurting their economies in the process. In declaring his determination to keep inflation under control at the bankers' conference on June 5, Bernanke said the aim was to ``foster sustainable economic growth.''
No Death Knell
In a press conference after yesterday's rate increase, Trichet described the ECB's strategy as one of ``progressively withdrawing the present degree of monetary accommodation'' rather than a move to a restrictive stance designed to slow growth markedly.
Bank of Japan officials have said they need to ``normalize'' their monetary policy after cutting rates to zero five years ago and pumping the banking industry with cash in an effort to end almost a decade of deflation.
``These interest-rate hikes are designed to preserve the economic expansion, not end it,'' said Allen Sinai, president and chief global strategist at Decision Economics Inc. in New York. ``The huge declines in the markets are not a death knell for the economy.''
To contact the reporter on this story: Rich Miller in Washington at [email protected]
Last Updated: June 8, 2006 21:26 EDT
DOW Price at posting:
0.0¢ Sentiment: None Disclosure: Held
A personalised tool to help users track selected stocks. Delivering real-time notifications on price updates, announcements, and performance stats on each to help make informed investment decisions.
(20min delay)