Rates Rise Worldwide

Thursday, June 08, 2006

--- UPDATED ---
What does Euroland have in common with India, South Korea, Turkey and South Africa? Higher interest rates!
Within 24 hours all five central banks raised their leading interest rate after Fed chairman Ben Bernanke's remarks last Friday seem to have cemented another quarter-point hike at the next FOMC meeting in market participants' minds. The ECB raised its overnight rate by 25 basis points to 2.75%, citing upside risks to inflation from energy prices and a pickup in economic activity in president Jean-Claude Trichet's introductory statement, which sounded like a re-run of earlier statements.
South Africa's Reserve Bank is less complacent with the inflation outlook and raised the repo rate 50 bp to 7.5%. This also helped to stop the slide of the Rand which has come under pressure from the unwinding of carry trades that once drove the Rand to its highs.
India hiked the reverse repo rate by 25 bp to 5.75%.
The Bank of Korea stepped up rates by 25 bp too, bringing the benchmark call rate to 4.25%.
Turkey lifted the overnight rate from 13.25% to 15%, also trying to stop the steep descent of the Lira.
The Bank of England kept the Bank Rate unchanged at 4.5%, probably having the housing market on its mind. The pound has weakend against the Euro as well.
The statements of the CB's sound similar, all pointing to higher inflation risks mainly from energy prices.
Repeating my view that money supply figures worldwide point to a lot more inflation than is measured by the various CPI's the recent round of rate hikes are a step in the right direction. Alas, they may come too late. An overnight rate of 2.75% in the Eurozone is certainly a real negative rate as consumer prices are spurting much faster. Even official EU inflation has acclerated to an annual rate of 2.5% (2.4%) in May.
Central banks seem to focus on foreign exchange rates quite a bit these days, with everyone trying to mainly keep the US dollar in its highly fragile equilibrium as financial markets would really start bleeding once the greenback goes into a tailspin.
Take note that both Turkey and South Africa's rate decisions are also meant to stop a slide of these currencies. Higher rates as a means to make a currency more "attractive" are a deceptive concept or we would all be investing in Zimbabwe. In the long run higher rates do not compensate for currency weakness as can be observed in the US dollar. Although Fed funds are at 5%, a Euro costs $1.26. This was also the case a year ago when Fed Funds were at only 3%.
Looking at my long checklist of unsolved problems in the USA I have no reason to veer off my course of caution. Neither have the twin deficits gone away nor inflationary risks. Not to speak of a horribly expensive war based on lies that appears set to become America's next Vietnam.
Imbalances Will Become The New Rules Of The Road
America's huge debts with the rest of the world will probably lead to a rewriting of rules that Westerners believed were carved in stone. So called global imbalances are nothing less than a reversal of the traditional debtor-creditor relations dating from the 20th century.
A look at the structural deficits of the US economy that has outsourced most production except that of killing devices does not exactly build optimism that the still biggest economy in the world will ever be able to repay its debts without a strong dose of inflation.
I have written before about the double dilemma the dollar faces, transforming it into a burden currency for the whole world. A strong dollar would further increase the trade deficit by slower exports while a weak greenback would add more inflationary pressures from higher import prices. And by now America is not only addicted to oil but also to all those cheap goods from China that fill Wal-Mart's aisles.
Markets Changing Behaviour
Markets have changed in the last weeks. It is not uncommon to see all asset classes rise or fall, contradicting old wisdom that money flowing out of markets has to flow into other markets. But these days investment classes take all the south route, leaving no safe haven and thereby fleecing all investors on the long side. This is remarkable.

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