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.
| UNITED STATES OF AMERICA |
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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.
| EUROPE |
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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.”
| UNITED KINGDOM |
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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.”
| JAPAN |
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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.
| SOUTH AFRICA |
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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.
| GENERAL – OIL AND GOLD |
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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.
| CONCLUSION |
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.
