Few of us, perhaps,
give much thought to the enormous
responsibility shouldered by just
four men over interest rates in
the four largest regions of the
world and the potential impact of
these decisions on the global economy.
These men, who need little introduction,
are Ben Bernanke, Toshihiko Fukui,
Mervyn King and Jean-Claude Trichet
– the current governors of the world's
most powerful central banks.
The central bank of a country is
responsible for setting interest
rate policy, which of course also
involves determining when interest
rates should rise or fall. We all
know that interest rates and their
direction have an enormous impact
on a country's economic growth prospects
and in addition, play a crucial
role in the stability of a country's
currency and markets. As a result,
economists and market forecasters
spend a great deal of time monitoring
the policy decisions of the world's
major central banks in an attempt
to gain useful insight into potential
interest rate movements. Key, too,
is keeping a very close watch on
the governors of these organisations
and understanding their stance on
these issues.
The United States Federal Reserve
is widely recognised as being the
most powerful central bank in the
world. The United States economy
is about triple the size of its
closest competitor (Japan – currently
at $4.5 trn, compared to the United
States at $12.5 trn). Ben Bernanke,
being Chairman of the Federal Reserve,
is therefore probably the most closely
observed of the four governors.
As Chairman of the Federal Reserve,
Bernanke also forms part of the
FOMC (Federal Open Market Committee),
which is the group within the Federal
Reserve that determines interest
rate policy. Ben Bernanke succeeded
Allan Greenspan in January 2006.
While his appointment came as no
surprise, the market has been watching
him closely as he is known for being
an advocate of "inflation targeting"
which is very different to the style
adopted by Greenspan. Bernanke is
very much an academic and is therefore
likely to place a lot more emphasis
on the use of mathematical and econometric
models than his predecessor did.
The Bank of Japan (BoJ), which meets
once or twice a month, is headed
up by Toshihiko Fukui. Fukui, who
has been with the BoJ since 1953,
succeeded Masaru Hayami as governor
in March 2003. He has been instrumental
in implementing a range of new policies
which aim to improve transparency.
Some of these policies include the
publishing of minutes from various
policy meetings, together with forecasts
from the BoJ. He is viewed as being
conservative and is probably the
least "known" of the four governors.
Jean-Claude Trichet, the president
of the European Central Bank (ECB),
probably has the most difficult
job of all in that he is responsible
for managing monetary policy for
a dozen countries. He succeeded
Wim Duisenberg in November 2003.
The mandate of the ECB is "sustainable
growth and price stability", which
is identical to the mandate followed
by the US Federal Reserve. The one
primary difference between the two,
however, is that the ECB endeavours
to keep inflation below the 2% mark
at all times. Because the Eurozone
is export driven (and largely export
dependent as a result), the ECB
tries to avoid any unnecessary currency
strength, as this would have a negative
impact on their exports. Trichet
has often been severely criticised
for being far too cautious and reactive
in addressing the two primary negatives
prevalent in the region – the high
levels of unemployment and economic
lethargy.
The Bank of England (BoE) is regarded
as being one of the most competent
central banks in the world. Under
the leadership of Mervyn King, the
current governor who took over the
role in June 2003, the bank is mandated
to "maintain monetary and financial
stability". In order to achieve
this, the BoE aim to maintain confidence
in their currency, while at the
same time keeping prices steady.
In addition, the Bank has an inflation
target of 2% in place. The monetary
policy of being "neither too restrictive
nor too accommodative" implemented
by King is often referred to as
the "Goldilocks" monetary policy.
While his term as governor of the
BoE perhaps can't be described as
a fairy tale, Mervyn King is certainly
trying to get "the porridge" just
right.
At the most recent meeting of the
FOMC in May, interest rates were
increased to 5%, reaching the highest
level in five years. In a statement
following the announcement, the
Federal Reserve intimated that there
was a possibility that rates could
be kept on hold for a short while
and that future economic data would
determine "the extent and timing"
of future increases. While the current
level of rates is viewed as being
"neutral", any further tightening
would be considered to be restrictive.
The market is undecided as to the
future direction of interest rates
and having a new Fed Chairman makes
a forecast even more difficult.
One view is that rates could pause
over the short term. The other view
is that rates are likely to continue
rising steadily. This school of
thought is motivated by the fact
that inflation is currently at the
upper level of the target set by
the Fed (2%). This makes the Fed's
task of keeping inflation under
control, while at the same time
not curbing growth, a very difficult
one indeed.
Consistently high energy prices
prevail and remain a very real threat
to inflation. Growth in the first
quarter of this year come in at
an annualised 4.8%, which is better
than the growth of 1.7% reported
for the last quarter of 2005. However,
it is expected that economic growth
should moderate during the course
of the year. The number of new jobs
created in April was less than expected
(138 000), coming in at the lowest
level since October 2005.
Interest rates ended the quarter
under review at 2.5%, following
a 25 basis point increase at the
March meeting of the European Central
Bank (ECB). Since our last report,
signs of renewed strength have been
evidenced in the Eurozone economy,
despite inflation remaining at the
top end of the target range of 2%.
Consistently high oil prices continue
to pose a real threat to the inflation
outlook. In addition, it is possible
that the current monetary position
may be too stimulative in that it
has fuelled an environment of increased
liquidity and a higher demand for
credit. This is likely to feed through
into the inflation numbers, which
could increase the potential of
further rate hikes in the region
this year.
Following economic growth of 1.4%
last year, the ECB were forecasting
economic growth of 1.9% for 2006.
However, a recent report has indicated
that the ECB have revised their
growth figure for 2006 upwards to
2.1%. According to Joaquin Almunia,
EU Economic and Monetary Affairs
Commissioner, "both the EU and the
euro area are expected to grow markedly
strongly this year."
At the most recent meeting of the
Bank of England (BoE) interest rates
were kept on hold at 4.50%. This
is the ninth consecutive month without
a rate change. Commenting after
the most recent meeting, Steve Radley,
chief economist at EEF said, "with
growth showing no signs of moving
above trend and inflation subdued,
it is far too early to start talking
of increases in rates.
The Bank must continue to keep its
finger off the trigger until there
is a stronger case for a move in
either direction." The high oil
price and its negative impact on
inflation remains a concern. The
BoE has an inflation target of 2%,
but a recent report produced by
accountants BDE Stoy Hayward, indicated
that it is estimated that "rising
energy prices would push inflation
up to 2.3% between April and June
as utilities companies increase
their prices." Following the recent
release of the quarterly inflation
report, Mervyn King, governor of
the BoE, indicated that "the inflation
report describes a benign central
view of steady growth with inflation
remaining close to the target."
According to the latest figures
from the Office for National Statistics,
GDP growth for the first quarter
of this year was 0.60%, increasing
the annual rate of growth to 2.2%,
which is an improvement from the
2005 figure of 1.8%. However, the
British Chambers of Commerce (BCC)
are of the opinion that "the upturn
is very fragile and many risks persist."
Although the economic recovery in
Japan is still fragile following
a decade of deflation, levels of
economic activity in the region
are improving. The Bank of Japan
(BoJ) confirmed that the economy
grew by 1.9% (annualised) during
the first quarter. This is significantly
better than expectations by analysts.
Commenting on the latest growth
numbers, BoJ governor Toshihiko
Fukui, said "as for the outlook,
we think there will be a long lasting
recovery". As a result, there is
already speculation of a possible
interest rate hike in the summer.
Commenting on the recent rising
CPI data, Mamoru Yamazaki (senior
economist at HSBC Securities) is
of the opinion that "the numbers
show that a rising trend in the
CPI is continuing and…the Bank of
Japan could raise interest rates
at any time from July onwards."
Despite these positive numbers,
the government has cautioned the
central bank not to raise rates
too soon to ensure that all evidence
of deflation is out of the system.
The unemployment rate is currently
at 4.1%, which is the lowest rate
in over 8 years.
Our domestic market did not escape
the volatility experienced by international
markets in mid May. This volatility
was prompted largely by the question
of whether commodity prices were
perhaps overdone, the fact that
the US Federal Reserve are "leaving
the door open for further interest
rate hikes" and an increase in risk
aversion. Commenting on these factors,
Old Mutual indicated in a recent
statement "the market fear is, however,
that high commodity prices might
raise inflation concerns, with monetary
authorities globally responding
by hiking interest rates and eventually
causing a severe slowdown in economic
activity". This could, in turn,
impact on the demand for commodities.
As a result, the Rand (and all other
emerging market currencies) came
under pressure, falling to 6-month
lows of R6.67 against the US Dollar.
In line with expectations, the Monetary
Policy Committee (MPC) kept interest
rates on hold during the quarter
under review. However, the MPC recently
alluded to that fact that the next
move in interest rates could be
up. Factors that could pose a risk
to the current benign inflation
numbers include higher global interest
rates, robust domestic demand, a
widening current account deficit,
sustained high oil prices, together
with a trend of rising household
debt. The latest Monetary Policy
Review by the Reserve Bank reports
"at issue then is how pre-emptive
the Bank should be, given the absence
so far of significant price increases
in the wake of high demand". Despite
inflation being benign and the consensus
view still being that interest rates
are likely to remain on hold this
year, the risk of an interest rate
increase at the next meeting of
the MPC has risen. One of the main
factors contributing to this increase
in risk is the sharp weakness of
the Rand in recent weeks. The Rand
ended the quarter at R6.64, R8.55
and R12.46 to the US Dollar, Euro
and British Pound, respectively.
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The oil price rose to levels exceeding
$70 a barrel during the quarter
under review, ending the quarter
at $69.03 a barrel, from $59.22
a barrel at the end of the first
quarter. Supply issues continued
to put upward pressure on prices
until early May. According to a
recent report on CNNFN, "besides
the loss of almost a quarter of
output in Nigeria due to militant
attacks, tensions between fellow
OPEC oil exporter Iran and the West
over Tehran's nuclear program have
helped underpin price gains this
year." Recent decisions by Bolivia
and Venezuela are expected to put
pressure on prices – Bolivia has
taken a decision to nationalise
all its gas fields, while Venezuela
will literally be doubling the taxes
levied on foreign oil companies
operating in their country. Refinery
problems and maintenance related
issues continue to put added pressure
on the supply of gasoline in the
USA. Despite these issues, however,
profit taking across all commodity
markets in mid May caused the price
of oil to decline from recent highs.
The United States is the world's
top consumer of gasoline and their
demand for gasoline usually peaks
during their summer driving season,
which commences shortly. This is
a major concern for oil markets.
In addition, hurricane season is
just around the corner. Commenting
on this, NaumanBarakat of Macquarie
Bank is of the opinion that, "the
impact of hurricanes on the gasoline
market will be bigger this year
than last." According to Barakat,
this is due to the fact that there
are less reserve supplies available
to deal with emergencies because
of changes in gasoline formulations.
According to Brian Hicks, a fund
manager in Houston, "right now the
Street is factoring in disruptions.
It looks like everyone is predicting
an active hurricane season." While
experts are predicting fewer storms
than last year, they are concerned
that the "warmer Gulf waters could
make this year's storms stronger,
faster developing and harder to
predict." Hurricane Katrina, which
hit the Gulf in August last year,
suspended 95% of oil production
in the region, taking months to
restore production levels.
The rise in the gold price showed
renewed strength this quarter, reaching
a high of $730.30 in early May (levels
last witnessed in 1980), before
ending the period under review at
$659 an ounce. This is 18.15% higher
than the close of $557.75 an ounce
at the end of February. Rising fears
over the Iranian nuclear crisis
fuelled concerns that sanctions
could be imposed by the US against
Iran over their nuclear status.
As a result, investors poured money
into gold (which is seen as a safe
haven or "store of value"), which
put upward pressure on the price.
These same fears impacted on the
oil price, due to the fact that
Iran is OPEC's second largest exporter
of oil. However, as highlighted
above, profit taking caused commodities
to retreat sharply from recent highs,
with gold not escaping the correction.
The profit taking was prompted by
a number of factors, including concerns
that a price bubble in commodities
"could hurt economic growth and
demand" and cause inflationary pressures.
Thank you to everyone who attended
the topical presentation hosted
with Prudential on the 18th May
at the Redlands Hotel. Prudential,
who manage over $250 billion worldwide,
is one of our preferred fund management
houses. The date of the Ashburton
seminar, scheduled for the last
quarter of this year, will be confirmed
in our next quarterly review.
QUARTERLY QUOTE
"Real integrity is doing the right
thing, knowing that nobody's going
to know whether you did it or not."
Oprah Winfrey
This report is based on information
sourced from various institutions,
both local and international. The
report reflects a variety of views
and is not intended to convey investment
advice. Please consult us to obtain
specific advice relevant to your
investment portfolio.
