Finncil Mrkets nd Monetry Policy - Assignment Example

Finncil Mrkets nd Monetry Policy [Nme of the school] [Nme of the a) Ws this interest rte increse foreseen by the finncil community Ws it expected The decision to raise rates was carried by seven votes to two. Rachel Lomax, deputy governor for monetary stability, and David Blanchflower, one of the monetary policy committee's external members, voted against the rise. Ms Lomax recently cited as a reason for her dissent the possibility that the economy might be able to grow faster without generating inflation because of the large rise in the workforce. One of the voters (Mr Tucker) admitted that he was torn between this view of the economy - which he dubbed the alternative story - and the orthodox view, namely, that with the economy operating close to capacity, companies were likely to seek to restore profit margins by raising prices and pushing up consumer price inflation. "In that sense I think the outlook is 'bimodal' - in terms of there being two main stories. The orthodox story, to which I gave most weight in my November vote, required a small tightening," he said. On the significance of the 15 per cent annual rise in broad money supply, Mr Tucker said it was important to look at what was contributing to the growth: "One has to get one's hands dirty in analysing the money numbers." (Daneshkhu, 2006) The rection of the finncil community to the increse of interest rtes by the Bnk of Englnd showed tht they believed tht the consumer price index would remin bove trget if rtes were left unchnged t 4.75 per cent. Growth ws firm nd hd left smll mrgin of spre cpcity, they rgued, while the risks from slowing US economy hd diminished. The still buoynt housing mrket might spur consumer spending, though it ws ccepted tht household indebtedness could ct s restrint. In ddition, the mjority remined concerned tht the upcoming New Yer py round my pose risk s workers noted tht the retil price index ws t n eight yer pek of 3.7 per cent. "There ws risk tht employees would seek to negotite higher wges in order to resist the erosion of their purchsing power ccording to tht index," sid the Bnk. (Daneshkhu, 2006) The mjority gin reiterted their concerns tht the fst pce of brod money growth could further fuel sset price infltion nd tht tht if infltion continued bove trget for much longer, tht might come to be reflected in infltion expecttions. ll these fctors posed upside risks to infltion. In contrst, one member, presumed to be Ms Lomx, "plced more weight on the downside risks to demnd nd infltion." (Fifield, 2006) The member lso rgued tht the ugust rte rise hd not yet fully been fully felt nd tht the Bnk ws underestimting the risks to demnd of slowing US economy. Rising unemployment ws likely to leve wge growth muted. nother member, believed to be Dvid Blnch flower, rgued tht the "current spike in infltion ws minly relted to lrge gs nd electricity price increses, which were still more thn offsetting the recent fllbck in petrol prices." Infltion would fll shrply next yer s their impct dissipted. Richrd McGuire t RBC Cpitl Mrkets sid the split vote might be interpreted by the mrket s reducing the momentum for nother increse in the cost of borrowing. "While it remins close cll, we continue to see the blnce of probbilities slnted towrd the Bnk of Englnd remining t the sidelines in Februry, view which hs received some support from tody's minutes." (Fifield, 2006) b) On wht grounds hs this interest rte increse hs been justified Rises in interest rtes re justified by the forecsting tht Bnk of Englnd hs mde in reference to the growth during the next yer nd infltion tht will remin t or bove its trget over the next two yers. Addressing the Financial Markets Association in London, Paul Tucker said he had voted for last month's quarter-point increase in the Bank's main rate to 5 per cent. "With headline inflation tangibly above target in the run-up to the main, new year wage bargaining season and with the market clearly expecting that policy would be tightened, a small increase in bank rate was, on balance, warranted to avoid any misperception that our reaction function had altered," he said. "I concluded that it was essential for the Monetary Policy Committee to act in a way that was most likely to keep inflation expectations anchored." (Moore, 2006) It was necessary to ensure people knew the Bank would act to control inflation and played down the role of the rapid money supply growth in his decision. Noting that half the rise was because of holdings by financial corporations, he said this could be due to structural change in the financial system. In this case, the strong rise in money supply did not of itself obviously have malign implications for money spending and inflation. Mr Tucker reiterated the Bank's recent warnings that a climate of low interest rates and low volatility might have prompted investors to become complacent about underlying risks in the financial market. It is a potential concern that, looking forward, financial markets may not be pricing for - which means that investors may not be insuring themselves against - the range of uncertainties that preoccupy the official sector. (Moore, 2006) c) Were there ny "hints" in the ltest Bnk of Englnd Infltion Report (ugust 2006) bout this interest rte rise Upon reviewing the infltion report of ugust 2006 Bnk of Englnd fced dilemm in deciding whether to cut interest rtes or to increse them. Infltionry pressures were mounting while growth momentum ws fding with little suggestion of pick-up in consumer spending or mnufcturing output in the short term. September's infltion dt nd consumer price infltion reched its highest rte since pril 1996 with rise from 2.4 per cent in ugust to 2.6 per cent. (Daneshkhu, 2006) Melnie Bker of Morgn Stnley wrned tht infltion could stick bove the BoE's 2 per cent trget until December 2006 nd tht prolonged overshoot, lsting until the third qurter of 2008, is possible, depending on oil price developments. Retil sles for September confirmed consumer survey reports of wek high street ctivity. The consensus forecst ws for n increse of 0.2 per cent, slowing yer-on-yer growth rte from 0.8 per cent in ugust to zero. (Moore, 2006) The infltion report overll looks pretty blnced, indicting tht the Bnk of Englnd believed it is touch nd go whether interest rtes will hve to rise once more over the coming months. Mr King sid tht lthough infltion ws likely to remin voltile over coming months, the risks to growth nd infltion were brodly blnced. The economy should continue to grow t bout trend next yer, buoyed by helthy expnsion brod, but might moderte in 2008, sid the Bnk. Infltion will pick up in ner term, sid Mr King, reflecting higher utility prices nd tuition fees, but will fll bck s energy costs decline nd import prices rise more slowly. (Daneshkhu, 2006) Nevertheless, there is dnger flling energy prices re offset by rising wges nd compnies seeking to widen profit mrgins. Mr King gin wrned of the possible infltionry consequences of the fst pce of recovery in wge growth. The chnces of nother qurter point increse in the cost of borrowing to 5.25 per cent my therefore depend on the outcome of the New Yer py round, nlysts sid. "If wge infltion rises in the next couple of months, rtes will probbly rise erly next yer, " sid Jonthn Sid t the Centre for Economics nd Business Reserch. c) Were there ny "hints" in the ltest Bnk of Englnd Monetry Policy Committee Minutes (October 2006 meeting) bout this interest rte rise The Bnk's decision to sty its hnd ws forecst by economists, but recent Reuters poll showed lmost unnimity in the belief tht the cost of borrowing will hit 5 per cent in November. Recent dt were evidently sufficiently benign for the Bnk's monetry policy committee to dismiss the need for n immedite rise. However, implicit in the Bnk's forecsts is the need for further monetry tightening to bring infltion bck in line with its 2 per cent trget. Consumer price infltion is currently 2.5 per cent nd is expected to spike higher over coming months s utility bills nd tuition fees mke n impct. (Garnham, 2006) Pressure for n increse in rtes hs come from signs tht the economy is growing t or slightly bove trend. Strong numbers on services from both the CBI nd the survey of purchsing mngers, hve shown the biggest sector of the economy is in robust helth. There is lso evidence tht mnufcturers re continuing to benefit from firly buoynt globl economy, prticulrly from n upturn in the eurozone. The housing mrket hs lso shown little sign tht the lst surprise hike in interest rtes in ugust hs crimped demnd, nd the resulting feelgood fctor in turn hs helped bolster consumer spending. On the other hnd, while growth remins helthy, finl dt on the economy sw second qurter expnsion revised down slightly from 0.8 per cent to 0.7 per cent. There ws lso shrp downwrd revision to the GDP defltor, mesure of infltion in the economy. John Butler t HSBC in note to clients this week sid: "On our estimtes the combined purchsing mngers' index is consistent with qurterly GDP growth of between 0.7 nd 0.8 per cent in Q3, which is mrginlly lower thn the 0.9 -1.0 per cent estimte implied in the MPC's centrl projection t the time of the ugust Report." (Garnham, 2006) The MPC my lso hve wnted to give itself more time to ssess the effects of shrp fll in energy prices over the pst month. lln Monks t t JPMorgn Chse Bnk hs noted tht Brent crude dropped below $58 brrel this week nd hs consequently reduced his forecst for infltion to pek in December from 3 per cent to 2.8 per cent. George Buckley t Deutsche Bnk predicted the Bnk would move in November nd explined why it hd been prepred to wit. (Garnham, 2006) The MPC will not hve been privy to the the September consumer price index dt t Thursdy's meeting, noted Mr Buckley. However by the time its gthers for the November discussion the committee will hve seen both the September nd October infltion numbers. In ddition, the MPC more often chnges rtes in months tht coincide with the publiction of the qurterly infltion report, with the next in November. Finlly, GDP dt for the third qurter re published in mid-October. (Garnham, 2006) " big question mrk still hngs over whether the Bnk will need to rise rtes gin this cycle. We think tht they will, but November move will hinge on n bove-trend Q3 growth reding - i.e. 0.7 per cent qurter-on-qurter or higher), infltion picking bck up gin in October nd n infltion forecst which suggests the need for further move, " sid Mr Buckley. (Dodd, Chisholm, 2006) "We expect these strs to be ligned gin by the time of the November meeting, but it is fr from foregone conclusion." (Dodd, Chisholm, 2006) e) What has been the reaction of financial markets to this interest rate increase Reaction of financial markets on the interest rate increase can be described as it follows: Financial market expectations as for the next move in interest rates to higher positions increased. Although the Monetary Policy Committee voted unanimously to maintain interest rates at 5% in December, there appeared a real risk that some members may be swayed by the latest economic figures and could advocate an increase to 5.25% this week. (Dodd, Chisholm, 2006) Although the European Central Bank (ECB) was widely expected to keep the refi rate at 3.5%, the press conference attracted significant market attention as financial markets assess the outlook for policy in 2007. Euro zone economic data have been robust of late and ECB president Trichet (head of the ECB) could signal further tightening ahead. We forecast interest rates could reach 3.75% by the end of Q1 2007. (Dodd, Chisholm, 2006) After the better than expected US payrolls report recently after the increase of interest rates, the dollar could find further support from economic data. The trade deficit was forecast to have stayed below $60bn for a second successive month in November, and retail sales were likely to have risen strongly again in December. The view of financial markets remains that US interest rates will not be cut in the first half of 2007. (Lloyds TSB, 2007) UK Interest rates are set to rise further in 2007, even talk of a US slowdown or sterling strength is not going to prevent the Bank of England from raising interest rates during 2007. The question is not if, but rather how high will interest rates go. (Lloyds TSB, 2007) Graph 11 The above chart shows that interest rate futures are already discounting a further rise by March 2007 to 5.25%. A rise to 5.5% is also expected with the 3 month LIBOR forecast to hit to 5.75% late 2007. The problem is that, unless the growth of the money supply is controlled, then interest rate rises of a further .25% is not going to be able to put much of a dent into inflation. It would take interest rates rising to a level where they hit the economy, push house prices into reverse and increase unemployment significantly to reign in inflation. (Lloyds TSB, 2007) Bibliography: Anna Fifield. UK interest rates stay at 4% for 13th month. Financial Times (Dec 05, 2006). Darren Dodd, Jamie Chisholm. NATIONAL NEWS BUSINESS AND ECONOMY: House prices rise despite rate increase. Financial Times (Sep 01, 2006) Elaine Moore. FT MONEY: Inflation forecast leads to uncertainty on rates. Financial Times (Nov 18, 2006). Lloyds TSB. Economics Weekly: Could the Bank of England hike rates this week Forex Weekly Reports (Jan 08, 2007). http://www.actionforex.com/forex_analysis_and_forecasts/forex_weekly_reports/economics_weekly:_could_the_bank_of_england_hike_rates_this_week_2007010815572/ Peter Garnham. STOCK MARKETS AND CURRENCIES: Dollar unharmed by weak CPI. Financial Times (Nov 17, 2006). Scheherazade Daneshkhu. NATIONAL NEWS: MPC member explains why he voted to raise interest rates. Financial Times ((Dec 12, 2006 ). Read More