Bloomberg News - Central bankers from Europe's Jean- Claude Trichet to
Canada's David Dodge may follow Federal Reserve Chairman
Ben S. Bernanke in an about-face, shifting toward
supporting economic growth and away from fighting inflation.
Economists are scrapping forecasts for higher interest
rates in the euro area, the U.K. and Canada as prospects
for expansion weaken, and some even say inflation will soon
recede enough to permit cuts. A similar change in outlook
may delay expected rate increases in Japan.
``Led by the Fed, central banks are having to change course
to avert a U.S.-led global downturn,'' says Paul Sheard,
chief global economist at Lehman Brothers Holdings Inc. in
New York.
Evidence may come this week as the European Central Bank
and the Bank of England each hold policy meetings Oct. 4.
While economists don't expect rate cuts this soon, ECB
President Trichet and Mervyn King, the U.K. governor, may
use the opportunity to signal greater unease about growth.
London house prices are falling by the most in three years,
while the record- high euro erodes profit at companies such
as France's Total SA.
The risk is that, with oil prices above $80 a barrel,
rising food costs and limited spare capacity, a tilt toward
easier credit might end up fanning inflation. After the Fed
on Sept. 18 cut its benchmark rate a half percentage point,
more than forecast, investors took out inflation insurance
by shifting money from bonds into commodities and
emerging-market stocks that tend to perform well when
prices are accelerating.
Gold Prices Rise
Gold prices ended last week at a 27-year high of $750 an
ounce. Emerging market stocks have rallied almost 20
percent in six weeks, according to an index compiled by
Standard & Poor's and Citigroup Inc.
``The problem in cutting interest rates in the current
environment is that markets respond by raising inflation
expectations,'' says Joseph Stiglitz, a Nobel-laureate
economist at Columbia University. ``That's a limitation for
monetary policy.''
For now, Europe's biggest central banks are on hold.
Economists polled by Bloomberg News are nearly unanimous in
predicting this week's policy meetings in London and Vienna
will end with the U.K.'s benchmark rate holding at 5.75
percent and the euro area's at 4 percent.
Which Way?
What's changing is the view of where the ECB and Bank of
England go from here. Just weeks ago, the consensus was
that they would only pause in their drive to push rates
higher. That view was reinforced by anti-inflation rhetoric
from central bankers themselves. Now, as credit-market
turmoil in the U.S. spreads overseas, the pause looks more
like a peak.
``We've seen a major change in the gestalt, where the
larger risks today are on the side of credit crunch,
financial contagion, economic slowdown, rather than the
pattern of increased inflation,'' former U.S. Treasury
Secretary Lawrence Summers, now a professor at Harvard
University, said in a Sept. 27 interview.
With loans harder to get in Europe, economists at Goldman
Sachs Group Inc. and Lehman Brothers shelved forecasts that
the ECB would raise rates. Lehman calculates that the rise
in the cost of credit in European markets has the same
effect on growth as a half-point rate increase by the
central bank.
Exporters to the U.S. are also suffering as their local
currencies surge, with the euro reaching a record $1.419
last week. Paris-based Total, Europe's third-largest oil
company, calculates that every 10-cent drop in the dollar
against the euro shaves 1.1 billion euros ($1.55 billion)
from its operating income. Canada's dollar last month
traded at parity with the U.S. currency for the first time
since 1976, prompting Montreal- based forest-products maker
Tembec Inc. to shutter sawmills in British Columbia.
Fast and Furious
The U.S. economy's slide has come ``faster and more
furiously than expected,'' says Erik Nielsen, chief
European economist at Goldman Sachs Group Inc. in London,
who forecasts growth in the euro area and the U.K. of about
2 percent next year, the weakest in three years. He
predicts the ECB will keep rates on hold.
David Brown, chief European economist at Bear Stearns Cos.
in London, goes further, projecting the ECB will lower
rates in the first quarter ``with more signs of economic
confidence starting to fracture.''
Rates may fall sooner in the U.K., where King extended
emergency funding to mortgage lender Northern Rock Plc to
remedy a ``severe liquidity squeeze'' just weeks after
saying he saw no ``international financial crisis.''
`High Vulnerability'
``The run on Northern Rock highlights the U.K. economy's
high vulnerability, especially via the housing market, to
the crisis in markets,'' says Michael Saunders, chief
western European economist at Citigroup Inc. He expects the
BOE, whose key rate is the highest in the Group of Seven
major industrial nations, to start cutting as soon as
November.
Lower borrowing costs may also be in store in Canada, whose
central bank on Sept. 5 stopped referring to a need to
increase its 4.5 percent benchmark rate and said market
turmoil threatens growth by slowing export demand.
Ted Carmichael, chief Canadian economist at J.P. Morgan
Securities in Toronto, says the Bank of Canada should lower
rates quickly ``to avoid a more severe economic downturn
than intended.'' He predicts a cut in December.
In Japan, whose economy shrank in the second quarter,
economists are pushing back predictions for when the Bank
of Japan will lift its 0.5 percent benchmark rate, the
lowest in the G-7. Investors see less than a one-in-10
chance of an increase at the BOJ's next meeting Oct. 10-11,
according to Credit Suisse Group calculations using
interest-rate swaps.
A Diminished Chance
``Concern over the financial crisis or liquidity crisis
will prevail through the year, which diminishes the chance
of a rate hike,'' says Naka Matsuzawa, chief strategist at
Nomura Securities Co. in Tokyo.
Not every central bank is doing an about-face. In China,
the fastest inflation in a decade will likely prompt higher
interest rates. Norway last week raised borrowing costs for
a sixth time this year amid a labor shortage. Price
pressures led Chile, Switzerland and Taiwan to boost their
key rates since early August, and each may do so again
before the year ends.
Inflation may still slow the response of the larger central
banks, unlike during the 1998 financial crisis, when G-7
central banks cut rates quickly and in concert. This time
the push towards cheaper borrowing costs may be spread over
months.
Less Leeway
``Monetary policy probably has less leeway today than it
did in 1998 to react to possible real effects of credit
market turbulence with interest rate cuts without
compromising price stability,'' Swiss central bank
governing board member Philipp Hildebrand said Sept. 24.
Inflation accelerated above the ECB's ceiling in September,
rising at a 2.1 percent year-over-year rate, the most in 13
months, official Eurostat figures showed last week.
Thomas Mayer, co-chief economist at Deutsche Bank AG in
London, says even if inflation risks are sustained they
will eventually run second to weaker expansion as the top
concern.
``Inflation will remain relatively sticky, but in the end
central banks will have to respond to the growth outlook,''
he says.
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