[A-List] Global economy: ECB intransigence

["Michael Keaney" <michael.keaney@xxxxxx>]

Here's another commentator bewailing "Dim" Wim Duisenberg's inability to
lower interest rates in the eurozone. I'm no fan of Wim, but I don't think
he deserves the sobriquet of "Dim", which even people like Doug Henwood
would have us believe is accurate, because that's what people on Wall Street
think. Actually it could be them who end up looking quite dim if, by leaving
rates at their current level, Wim and co. are preparing for a future
rocketing of oil prices should any hostilities commence in the Gulf region.
The sharp differential between US and EU rates is so pronounced that
Financial Times commentators are beginning to suggest that we might revert
back to a situation in which exchange rates are supported, rather than
undermined, by relatively high interest rates. They cite the weakening of
the dollar vis a vis the euro, which suits eurozone members very well, of
course, given that oil is priced in dollars and any weakening of the dollar
would offset very nicely any rise in oil prices caused by an invasion of
Iraq. And since the remit of the ECB is to control inflation, and since the
price of oil is a major determinant of inflation (as evidenced during the
last Gulf war), this might in fact be very savvy central banking, contrary
to the popular image of doctrinaire monetarism that permeates most
mainstream media coverage (given a heavy nod from the US eager to undermine
the credibility of the euro). And lest anyone fear, no I am not applauding
Wim for his enlightened monetary policy -- rates could have and should have
been much lower a long time ago, although the proviso of US rivalry remains,
and in any case Wim and co. hardly share my political views. The ECB has to
protect the euro's credibility by playing a defensive game that is the
lesser of two evils -- if it follows the Keynesian route it risks stoking
the inflation that will lead "the markets" to sell, thereby undermining it.
The alternative is to endure the sticks and stones of the financial media
whilst biding time for as long as it takes for the improbably high US dollar
to tumble. Then we'll see who's really dim.



Stephen King: ECB needs to act fast before the problems get worse
The aggressive cuts in US interest rates have worked to boost US
competitiveness
The Independent, 11 November 2002

Well, it wasn't to be. Hopes that there would be a co-ordinated series of
interest rate cuts around the world clearly made no impression whatsoever at
either the European Central Bank or the Bank of England. For the Bank of
England, the decision to do nothing was understandable: the Halifax bank's
alleged house price inflation of more than 30 per cent year on year must be
leaving some members of the Monetary Policy Committee feeling slightly
queasy. For the European Central Bank, the lack of action is less explicable
given the renewed signs of weakness in many parts of the eurozone economy.

Once again, then, the Federal Reserve has been left on its own. The Fed is
not a central bank that likes to waste time. Renewed signs of weakness - a
"soft spot" within the United States economy, as the Fed chose to put it -
provided the justification for a substantial cut of 0.5 per cent in its key
Fed funds rate. Even the Fed, however, doesn't want to get too carried away:
it indicated that its new policy position was one of "neutrality", seemingly
suggesting that there will be no more rate cuts in the remainder of this
year.

US short-term interest rates are now extraordinarily low. At just 1.25 per
cent, the Fed funds rate is now well below the then daringly low trough - 3
per cent - seen during the credit crunch at the beginning of the Nineties.
Interest rates have come down a long way. At the end of 2000, the rate on
Fed funds was as high as 6.5 per cent. In total, then, short-term interest
rates have fallen by a total of 5.25 per cent, a very sizeable amount of
monetary easing by anyone's standards.

By now, you would have thought that the policy should be working. Ask a few
American companies, however, and they will tell you a different story. The
left-hand chart shows why. On this chart, I have plotted the Fed funds rate,
the yield on 10-year Treasuries and the yield on BBB corporate bonds - in
other words, the rate that companies have to borrow at on capital markets if
they're not in particularly good financial shape, as determined by the
credit ratings agencies.

The extent of rate declines has varied significantly. Fed funds has
obviously fallen a long way. Recently, there's also been quite a lot of
progress on Treasury yields, suggesting that it has become cheaper for the
US government to borrow. For BBB-rated companies, however, there has been
scant progress. And there are now a lot more of them: many companies that
were previously seen to be in good financial shape have had their credit
ratings downgraded, leaving them unable to benefit from the lower borrowing
costs that the Fed has tried to put in place.

The lack of any substantial decline in borrowing costs for a lot of
companies is bad enough, but things get even worse when you take into
account the degree to which pricing power has been eroded. In the US, one
closely monitored measure of pricing power for companies is producer prices
of finished goods, stripping out the volatile food and energy components. At
the beginning of 2001, when the Federal Reserve first started to cut
interest rates, producers could shove up their prices by 1.9 per cent on an
annual basis. By the beginning of this year, producers could manage
increases of only 0.3 per cent. By September, producers were having to cut
prices by 0.4 per cent on an annual basis.

In other words, although the cost of borrowing has hardly shifted for a lot
of companies, the ability to raise prices has been severely curtailed. Put
another way, despite the Fed's best efforts to loosen monetary policy, the
brutal truth is that, for companies, real interest rates - adjusted for
pricing power - have actually risen significantly over the past two years.

There is, however, another source of relief - and some American companies
will be welcoming this with desperately open arms. Although the cost of
borrowing has not come down, another safety valve has come into play. Dollar
depreciation has become a reality over the past 18 months. You might find
this difficult to believe, but the facts show that the euro has been in the
ascendant since the middle of 2001. Back then, the euro was worth only about
84 cents. Now it's worth more than $1 (see right-hand chart).

In other words, the cuts in US interest rates - which, after all, have been
a lot more aggressive than those delivered in the eurozone - have worked to
boost US competitiveness. Rate cuts may not have led to a decisive recovery
in the stock market and they may not have eased the debt burden for
companies, but they have certainly improved the relative price of US goods
on global markets.

Is this good news? It depends whom you ask. For US exporters, the fall in
the dollar doubtless comes as a welcome relief. However, if the dollar has
fallen in value, so have the Chinese renmimbi and a host of other Asian
currencies that are linked to the US dollar. In other words, the dollar's
weakness is, in truth, more a case of euro strength. On this basis, dollar
depreciation is a straightforward "beggar-thy-neighbour" policy, reducing
some of the pressures on the US corporate sector by shifting the burden of
adjustment onto economies in Europe.

Blaming the Americans for this result is, of course, a little unfair. After
all, the rate cuts were not intended solely to deliver a reduction in the
value of the dollar: the Fed doubtless hoped to deliver a series of
improvements to the fabric of the domestic US economy. The post-bubble
hangover has, however, put paid to many of these hopes. It's increasingly
looking as though the decline in the dollar is the only direct way in which
lower interest rates are beginning to benefit US companies.

The impact on Europe of dollar depreciation should not be taken lightly. The
most obvious way in which the eurozone and the UK are affected by dollar
depreciation is through a loss in competitiveness. This, however, is not the
only effect. European investors who bought US assets with such enthusiasm in
the late Nineties are now beginning to discover why Americans were so happy
to offload the very same assets. The income generated from these assets is a
lot lower than expected, the capital value of the assets has come down a
long way in dollar terms and there has been even more destruction in either
euro or sterling terms. So Europeans are being punished now for the
generosity they showed towards all things American only a few years ago.

This is why the European Central Bank's failure to cut rates is so
disturbing. Yes, the ECB has failed to hit its inflation target but, then
again, no one else has got a target that is so draconian. The key point,
however, is that the ECB seems to be of the view that events in the US have
no real impact on events in Europe. That view is wrong. If the only way in
which the Fed can stimulate anything like recovery is through dollar
depreciation, the ECB had better get rates down fast. Otherwise, Europe will
have even more problems than the US in adjusting to a world of lower growth,
low inflation and corporate debt that remains at uncomfortably high levels.

Stephen King is managing director of economics at HSBC.

-----

Looking for strength in the US dollar
By Kevin Morrison
FT.com site; Nov 10, 2002

Now that questions about interest rate movements have been answered, focus
will switch to the US dollar and whether its slide against major currencies
continues.

The interest rate differential between the US federal funds rate to other
Group of Seven, excluding Japan because its central bank has a zero interest
lending rate, has made the greenback a low yielding asset.

Hence the flight by investors last week out of the US dollar following the
Federal Bank's surprise 50 basis point chop. On Friday, the US dollar was at
a 2-year low against the sterling, a 3-month low against the Euro and a
2-month low against the yen.

Alison Montgomery, foreign exchange strategist at Morgan Stanley, said the
dollar's downward move will be closely watched by traders this week. The US
dollar has fallen ¥5 against the Japanese currency in the past 3 weeks to
hover close to the ¥120 level, a point where rumours of Bank of Japan
intervention are reignited.

US economic data released this week was likely to show further weakness in
the world's biggest economy, which is expected to be reinforced by comments
by Federal Reserve chairman Alan Greenspan when he testifies on the economic
outlook to the joint Economic Committee on Wednesday. "Any comments about
fiscal stimulus to the US economy will be closely monitored, as Mr Greenspan
has indicated that the Fed is not going to do any more on the monetary front
after moving to a neutral bias," Ms Montgomery said.

Investors will also have the first chance to gauge consumer reaction to the
rate cut with the release on Friday of the University of Michigan consumer
confidence preliminary survey for November.

Economists are forecasting a slight rise in consumer sentiment from last
month's drop to a 9-year low. The Michigan survey comes a day after US
retail sales in October are expected to show another fall of about 0.2 per
cent, a slower rate than the 1.2 per cent decline in September.

Although the European Central Bank didn't follow the Fed's lead and chose
instead to keep the refi rate at 3.25 per cent, fixed interest investors are
still factoring in a quarter of a percentage point rate cut at the next ECB
meeting on December 5.

However, UK fixed interest investors are no longer factoring in a rate cut
by the Bank of England before the end of the year, as UK gilt prices fell
sharply after the BoE keep rates steady at 4 per cent.

The rationale of bond investors was expected to be supported by the release
on Wednesday of the BoE's inflation report, which may highlight inflationary
pressures. HSBC said in a report last week that it expects the BoE to
increase its inflation target over the next 6-to-9 months.

Tuesday's release of the UK retail price index, was expected to show a rise
of 2.2 per cent in October from 2.1 per cent in September, and nudging
closer to the 2.5 per cent inflation medium term target set by the BoE. The
expected higher RPIX follows a 30 per cent rise in UK house prices in the
year to October, according to the latest Halifax survey. Further weakness in
Eurozone economies are likely to be highlighted by the EU Commission on
Wednesday which is due to slash its Eurozone growth forecasts for 2003 to
about 2 per cent from the current forecast of 2.9 per cent.

In Japan, the release of the third quarter GDP figures is likely to show the
country's economic recovery was short-lived with a drop in the growth rate
of rise by 0.5 per cent on the June quarter, giving an annual rate of 2 per
cent, down on the 2.6 per cent at the end of June. Although some economists
are looking at the annual GDP rate falling to 0.5 per cent after only a 0.1
per cent gain in the July to September period.

Dell Computers, the PC maker, is the highlight of US corporate earnings this
week with the release of its third quarter results on Thursday. Dell has
already raised its Q3 revenue guidance and assured investors that its
earnings will be at the high end of expectations.

With about 90 per cent of US third quarter earnings reported, Europe and
Japan will again be the focus for corporate earnings.

In Europe, UBS, Commerzbank, Credit Lyonnais, Societe Generale, Credit
Suisse, Allianz, Bayer, BASF, EADS, RWE, Siemens, Cable & Wireless, Deutsche
Telekom and Vodafone report.

In Asia, Mazda, Mitsubishi Motors, Mitsui, Mitsubishi Corp, Nippon Oil and
Hyundai Motor all report.