Seeing the Interest Rate Forest

Despite growing expectations that the Federal Reserve's next move will be to cut rates, its counterparts overseas seem to be heading in the opposite direction.

In "ECB says `Vigilance' Required, Signals Rate Increase," Bloomberg notes the more hawkish stance of monetary officials in the Eurozone.

The European Central Bank said "strong vigilance'' is required to ensure inflation doesn't accelerate, signaling it will raise interest rates next month.

"Strong vigilance remains of the essence so as to ensure that risks to price stability over the medium term do not materialize,'' the Frankfurt-based central bank said in its monthly bulletin published today. "The ECB's monetary policy remains accommodative, with the key ECB interest rates still at low levels.''

The ECB has raised borrowing costs to contain inflation after the euro-region economy expanded at the fastest pace in six years last year, giving companies more room to increase prices and encouraging workers to demand more pay. ECB President Jean-Claude Trichet has used the word ``vigilant'' to flag each of the six rate increases since late 2005.

United Kingdom policymakers also seem to be on the same page, according to a report in Britain's Daily Telegraph.

The Bank of England warned yesterday of another interest rate rise, deepening the gloom for homeowners who are struggling with mortgage payments.

In its quarterly inflation report, the Bank said that inflation was on course to decline sharply over the year, settling at around the Government's two per cent target by the end of 2008.

However, this forecast is based on City expectations for one further quarter-point rise in interest rates to 5.5 per cent.

This would be the fourth interest rate rise since last August, and could push many struggling borrowers into defaulting on their mortgages or having their homes repossessed.

Economists have pencilled in May as the most likely month for an interest rate rise, although Michael Saunders, at Citigroup, warned that it could come as early as March.

Yesterday, AFX reported that the Swedish Central Bank lifted its short-term reference rate and indicated that wasn't the end of it.

The Riksbank hiked its repo rate to 3.25 pct from 3.00 pct, and said it believes the repo rate needs to be raised by a further 25 bp within the next 6 months.

"After that it will probably be possible to pause before making a further increase," the Riksbank said.

The Bank said it expects its repo rate increases to contribute to inflation being on target two years ahead and to a 'balanced development' for the economy.

There were signs that the monetary climate was getting decidedly more frosty thousands of miles away, too. Bloomberg notes what many see as the likely fallout from Japan's latest round of economic data.

Japan's economy grew at the fastest pace in almost three years as consumer spending rebounded and business investment jumped, stoking speculation the central bank may raise interest rates.

Gross domestic product in the world's second-largest economy expanded at an annual 4.8 percent pace in the three months ended Dec. 31, the Cabinet Office said in Tokyo today, exceeding the 3.8 percent median estimate of 38 economists surveyed by Bloomberg News. Third-quarter growth was revised to 0.3 percent from 0.8 percent.

The yen gained and the chance the Bank of Japan will raise rates next week climbed to 54 percent, from 40 percent late yesterday, according to calculations by Credit Suisse Group based on interest-payment trading. Governor Toshihiko Fukui cited weak consumer spending and slow inflation as reasons his policy board kept borrowing costs at 0.25 percent at its last two meetings.

"The report increases the possibility the central bank will raise rates," said Satoshi Kon, who helps manage the equivalent of $19 billion in Tokyo at Pension Fund Association. "Consumption was stronger than many of us anticipated."

The Chinese have also been taking aggressive steps to rein in an overheating economy. In "China Raises Lenders' Reserve Ratio to 10 Percent," Bloomberg reports on the latest development.

China ordered banks to set aside more money as reserves for the fifth time in eight months to cool inflation and investment in the world's fastest-growing major economy.

Lenders must put aside 10 percent of deposits from Feb. 25, up from 9.5 percent, the Beijing-based People's Bank of China said in a statement on its Web site, immediately before the start of a week-long Lunar New Year holiday.

Central bank Governor Zhou Xiaochuan is concerned that cash from a record trade surplus is stoking excess investment, raising the risk that inflation will accelerate from 2.2 percent in January. Zhou has increased interest rates twice since April and used bill sales and bank reserve requirements to rein in the supply of money, while resisting calls from the U.S. and Europe to let the yuan appreciate faster.

"The right diagnosis for China is to allow the currency to appreciate to slow exports," said Liang Hong, an economist at Goldman Sachs Group in Hong Kong.

The People's Bank estimates each 0.5 percentage point increase in the bank reserve ratio cuts the amount available for lending by 150 billion yuan ($19.4 billion). China's economy, the world's fourth largest, expanded 10.7 percent last year, more than triple the pace of growth in the U.S.

The yuan rose today to the highest since a link to the dollar ended in July 2005. The currency was up 0.16 percent to 7.7426 per dollar at 5:28 p.m. in Shanghai.

'War on Investment'

The central bank will raise bank reserve requirements at least once more this year, according to 12 of 14 economists surveyed by Bloomberg News last month. The ratio is up from 7.5 percent in June last year.

"The war on investment isn't over," said Dariusz Kowalczyk, chief investment strategist at CFC Seymour Ltd., a financial services company, in Hong Kong. "Inflationary pressures have crept higher and the central bank is a little concerned."

Consumer prices rose more quickly in December and January than in the previous 20 months, increasing 2.8 percent in December. Producer prices jumped by the most in five months in January. Investment and lending may rebound, increasing the risk of accelerating inflation, the central bank said this month.

Over in Hong Kong, The Standard writes that "Banks still feel pressure to raise rates."

US Federal Reserve chairman Ben Bernanke's comments Wednesday, suggesting inflation pressure in the United States is now easing, boosted the Hong Kong dollar, causing interbank lending rates to fall Thursday.

However, as liquidity continues to be squeezed out of the banking system, lenders are still under pressure to raise interest rates, senior bankers believe.

Finally, policymakers in another fast-growing Asian nation are also getting nervous, according to IANS.

Concerned over the accelerating inflation and to weed out liquidity from the Indian banking system, the Reserve Bank of India (RBI) Tuesday hiked the cash reserve ration (CRR) rates by 0.5 percent in two stages.

This is the second time in the last couple of months the central bank has raised the amount of money that commercial banks are required to park with the apex bank to curb excess liquidity.

From March 3, Indian commercial banks will have to keep 6 percent of cash deposits instead of the present 5.5 percent.

Announcing the hike, RBI deputy governor Rakesh Mohan said the central bank would use all its monetary policy tools to curb price pressures.

It seems that those who are only focusing on what is happening inside our shores might not be seeing the interest rate forest for the trees.