Thursday, November 01, 2007
Fed cuts, Bean stresses the uncertainty
Posted by David Smith at 10:00 AM
Category: Thoughts and responses

bean.jpg

The Federal Reserve cut the Fed Funds rate from 4.75% to 4.5%, as expected, but suggested that further reductions were by no means a done deal. Part of the reason for that is the inflationary pressure from high oil prices, also emphasised by Charlie Bean, the Bank of England's chief economist.

In his speech, Bean ran through a number of routes in which the credit crisis could impact on growth. But he also noted that the UK economy was starting from a strong position, that the world economy continues to power ahead and that "we cannot afford to relax on the inflation front". As for those credit crisis effects: "It is difficult to assess with any degree of precision the impact on the economy of the recent developments in financial markets." The speech is available here.

Comments

I know that the dollar has lost ground against the yen over the last three months. However, I'm surprised about the reaction of the yen following yesterday's interest rate cut in the US. Why did the yen appreciate whne US interest rates fell? Surely the yen carry trade is less profitable than it once was due to falling US interest rates. The Fed talks a tough line, but do the markets REALLY think that the Fed won't cut again? Is the Bank of Japan operating a dirty float? A weak yen certainly helps Japanese exporters!

David, will the yen carry trade unwind if US interest rates continue to fall?

When we will see some serious drops in the dollar against the yen?

Posted by: Nigel at November 1, 2007 02:36 PM

Bean would be correct - playing with the US' inflation numbers at this tool suggests that all that separates the Fed from a quarter point increase in the Federal Funds Rate would a 0.3% uptick in year-over-year inflation (less food and energy), assuming the US' official unemployment rate holds level at 4.7%.

Posted by: Ironman at November 1, 2007 03:00 PM

Re: the yen and the carry trade. This from Reuters today:

TOKYO, Nov 1 (Reuters) - Bank of Japan Governor Toshihiko Fukui stuck to his modestly hawkish tone on Thursday, suggesting interest rates should rise gradually even as economic risks heighten, partly to put a brake on excessive yen carry trades.

Speaking in parliament a day after the central bank decided to keep rates on hold at 0.50 percent, Fukui reiterated that downside risks for Japan's economy were heightening, among them the potential impact of U.S. subprime mortgage market problems on global economic and market developments.

But he said it was important to raise rates at the appropriate time to prevent sharp economic swings and prevent an excessive buildup in yen carry trades, in which investors borrow the low-yielding yen and invest in assets with higher returns.

"I am painfully aware of the difficulty of choosing the right time" for raising rates, Fukui told an upper house financial and monetary affairs committee.

"But if we waver too much it could cloud our policy judgment, and we cannot let that happen," he said.

The BOJ has said it needs to raise rates gradually in line with improvements in economic and price conditions, as keeping rates low for too long could lead to the economy overheating.

But many economists now believe the BOJ will sit tight until early next year to gauge the impact of financial turmoil on U.S. economic growth, a Reuters poll showed on Thursday.

Posted by: David Smith at November 1, 2007 06:08 PM