Wednesday, July 4, 2007

ECB, Bank of England and Bank of Canada

ECB: July 5 at 11:45 GMT
The European Central Bank will keep rates on hold at 4% but the markets will be listening intently to the MPC President – Jean Claude Trichet, for any signals that rates will be raised in forthcoming months. Markets expect a rise in rates to 4.25% in September, with one more rate increase before the end of the year, to bring the underlying rate for the euro group of countries to 4.5%. ECB members have been decidedly hawkish of late and with oil prices back over $70 a barrel, it will be a surprise if Trichet does not point to price stability risks in the medium term. The Bank should retain its 'accommodative’ policy and reiterate that interest rates remain ‘moderate.’ Despite the fact that inflation has been held below the Bank’s target 2% level all year, the euro zone economy is expanding at a higher rate than forecast and with this week’s manufacturing and services indices revealing increased expansion in June, the MPC will certainly feel the economy has plenty of scope for further monetary tightening. While retail sales have faltered in recent months, employment numbers across the zone have hit new highs and the Bank foresee increased spending in the second half of this year. Trichet should signal on Thursday a rate hike to take place within the next two months and markets should be left with an impression of 1 further rate hike this year. Anything less could send the euro into retreat.

BoE: July 5 at 11:00 GMT
This is difficult to call because of the vote at the last MPC meeting in June, when the Governor found himself in a 5-4 minority - the committee voted to keep rates on hold. Since that meeting we have seen a series of weaker inflation data, although there appears to be little letup in the rise in house prices. Hawks on the Board will be helped by some recent economic data, where we saw quarter one GDP revised upwards to 3%, further tightening in the employment sector and a widening in expansion in the country’s services sector. With markets expecting rates to climb at least twice more, the hawks will be trying to force home a rate rise this month and will see no point in waiting until August. The result will depend on the hawks being able to bring at least one of the doubters over to their side on Thursday. Governor King irresponsibly intervened in the debate the day before the UK consumer price inflation data for June was released a few weeks back, when the timing of his blatant call for further rate rises biased the market's response to actual data. This had the impact of elevating the country’s currency and keeping it there, despite the fact that consumer prices the next day reported a sharp decline in the annual inflation rate from 2.8% to 2.5%. If the MPC fail to approve a rate rise Thursday, Governor King’s authority and influence will be seriously undermined again and he may rightly find himself in an untenable position. The lack of direction and consensus from the Bank of England over the past 12 months has been startling to say the least and this Thursday could be another day when the MPC does not cover itself in glory. Of course we will not know what exactly transpired for 2 weeks, when the minutes of the meeting are released. There remains a very good chance that rates will not rise this Thursday as it makes sense for the MPC to wait until August, when the Bank's quarterly inflation report is due to be released. The reasons for voting against a rate rise in June still hold true in July and with the MPC not having access to the latest consumer price inflation data (it is not released until July 16), it makes sense to wait. It will be a close run thing, that is for sure, but whichever way it goes, it could prove to be another uncomfortable day for the Bank’s Governor – Mervyn King, who has failed miserably to exact any meaningful influence over this particular MPC.

BoC: July 10 at 13:00 GMT
The Bank of Canada has an unenviable task ahead of them next Tuesday, having all but signalled to the markets in their statement at the end of May that a rise in interest rates was a near certainty. The Bank made a cardinal error by showing their hand too early, because it came at a time when the Canadian dollar was appreciating at unprecedented levels and came before the country’s latest inflation data release (for May) which subsequently saw a decline in both the country’s headline and core inflation rates. Since the beginning of June economic data out of Canada has been less than impressive, with lower than expected gains in employment, manufacturing output falling, retail sales slowing significantly and growth flat into quarter 2. Despite this, the Canadian dollar has been appreciating to new 30 year highs against its US counterpart, as speculators bet on 2 or more rate rises from the country’s Central Bank and trade the currency like it was a commodity. There are plenty of arguments for why the Bank should keep rates on hold this month, but the fact they have already signalled to markets that rates ‘may’ rise, means they will probably have to make good their promise and proceed with a 25 basis point hike this month. The Bank has quite a complex procedure for determining monetary policy, and the whole process begins this Friday, with the decision only announced next Tuesday. The Bank chose to refrain from commenting on the value of the Canadian dollar in its last statement, which was another mistake, as it in effect gave license to speculators to push the currency higher and higher, even against a background of softer data. The Bank would do well to look at the experience of the RBNZ that made a failed attempt to rein in the currency – after having raised interest rates there to levels that were going to cause serious problems for the currency. If the Bank of Canada go ahead with a rate increase next Tuesday, as expected, and leave the door open for possible future rate rises, then they will have lost control over the direction of the country’s currency. The dependency of Canada’s economy on the US market is enormous, but the overvalued Canadian dollar may ultimately prove to be the economy’s downfall and the impact may be seen sooner rather than later and subsequently lead to a reversal in monetary policy.