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Trichet, Dodge, King May ***ow Bernanke in U-Turn on Policy
By Simon Kennedy and Rich Miller
Oct. 1 (Bloomberg) -- Central bankers from Europe's Jean- Claude Trichet to Canada's David Dodge may ***ow Federal Reserve Chairman Ben S. Bernanke in an about-face, shifting toward supporting economic growth and away from fighting inflation.
Economists are scrapping forecasts for higher interest rates in the euro area, the U.K. and Canada as prospects for expansion weaken, and some even say inflation will soon recede enough to permit cuts. A similar change in outlook may delay expected rate increases in Japan.
``Led by the Fed, central banks are having to change course to avert a U.S.-led global downturn,'' says Paul Sheard, chief global economist at Lehman Brothers Holdings Inc. in New York.
Evidence may come this week as the European Central Bank and the Bank of England each hold policy meetings Oct. 4. While economists don't expect rate cuts this soon, ECB President Trichet and Mervyn King, the U.K. governor, may use the opportunity to signal greater unease about growth. London house prices are falling by the most in three years, while the record- high euro erodes profit at companies such as France's Total SA.
The risk is that, with oil prices above $80 a barrel, rising food costs and limited spare capacity, a tilt toward easier credit might end up fanning inflation. After the Fed on Sept. 18 cut its benchmark rate a half percentage point, more than forecast, investors took out inflation insurance by shifting money from bonds into commodities and emerging-market stocks that tend to perform well when prices are accelerating.
Gold Prices Rise
Gold prices ended last week at a 27-year high of $750 an ounce. Emerging market stocks have rallied almost 20 percent in six weeks, according to an index compiled by Standard & Poor's and Citigroup Inc.
``The problem in cutting interest rates in the current environment is that markets respond by raising inflation expectations,'' says Joseph Stiglitz, a Nobel-laureate economist at Columbia University. ``That's a limitation for monetary policy.''
For now, Europe's biggest central banks are on hold. Economists polled by Bloomberg News are nearly unanimous in predicting this week's policy meetings in London and Vienna will end with the U.K.'s benchmark rate holding at 5.75 percent and the euro area's at 4 percent.
Which Way?
What's changing is the view of where the ECB and Bank of England go from here. Just weeks ago, the consensus was that they would only pause in their drive to push rates higher. That view was reinforced by anti-inflation rhetoric from central bankers themselves. Now, as credit-market turmoil in the U.S. spreads overseas, the pause looks more like a peak.
``We've seen a major change in the gestalt, where the larger risks today are on the side of credit crunch, financial contagion, economic slowdown, rather than the pattern of increased inflation,'' former U.S. Treasury Secretary Lawrence Summers, now a professor at Harvard University, said in a Sept. 27 interview.
With loans harder to get in Europe, economists at Goldman Sachs Group Inc. and Lehman Brothers shelved forecasts that the ECB would raise rates. Lehman calculates that the rise in the cost of credit in European markets has the same effect on growth as a half-point rate increase by the central bank.
Exporters to the U.S. are also suffering as their local currencies surge, with the euro reaching a record $1.419 last week. Paris-based Total, Europe's third-largest oil company, calculates that every 10-cent drop in the dollar against the euro shaves 1.1 billion euros ($1.55 billion) from its operating income. Canada's dollar last month traded at parity with the U.S. currency for the first time since 1976, prompting Montreal- based forest-products maker Tembec Inc. to shutter sawmills in British Columbia.
Fast and Furious
The U.S. economy's slide has come ``faster and more furiously than expected,'' says Erik Nielsen, chief European economist at Goldman Sachs Group Inc. in London, who forecasts growth in the euro area and the U.K. of about 2 percent next year, the weakest in three years. He predicts the ECB will keep rates on hold.
David Brown, chief European economist at Bear Stearns Cos. in London, goes further, projecting the ECB will lower rates in the first quarter ``with more signs of economic confidence starting to fracture.''
Rates may fall sooner in the U.K., where King extended emergency funding to mortgage lender Northern Rock Plc to remedy a ``severe liquidity squeeze'' just weeks after saying he saw no ``international financial crisis.''
`High Vulnerability'
``The run on Northern Rock highlights the U.K. economy's high vulnerability, especially via the housing market, to the crisis in markets,'' says Michael Saunders, chief western European economist at Citigroup Inc. He expects the BOE, whose key rate is the highest in the Group of Seven major industrial nations, to start cutting as soon as November.
Lower borrowing costs may also be in store in Canada, whose central bank on Sept. 5 stopped referring to a need to increase its 4.5 percent benchmark rate and said market turmoil threatens growth by slowing export demand.
Ted Carmichael, chief Canadian economist at J.P. Morgan Securities in Toronto, says the Bank of Canada should lower rates quickly ``to avoid a more severe economic downturn than intended.'' He predicts a cut in December.
In Japan, whose economy shrank in the second quarter, economists are pushing back predictions for when the Bank of Japan will lift its 0.5 percent benchmark rate, the lowest in the G-7. Investors see less than a one-in-10 chance of an increase at the BOJ's next meeting Oct. 10-11, according to Credit Suisse Group calculations using interest-rate swaps.
A Diminished Chance
``Concern over the financial crisis or liquidity crisis will prevail through the year, which diminishes the chance of a rate hike,'' says Naka Matsuzawa, chief strategist at Nomura Securities Co. in Tokyo.
Not every central bank is doing an about-face. In China, the fastest inflation in a decade will likely prompt higher interest rates. Norway last week raised borrowing costs for a sixth time this year amid a labor shortage. Price pressures led Chile, Switzerland and Taiwan to boost their key rates since early August, and each may do so again before the year ends.
Inflation may still slow the response of the larger central banks, unlike during the 1998 financial crisis, when G-7 central banks cut rates quickly and in concert. This time the push towards cheaper borrowing costs may be spread over months.
Less Leeway
``Monetary policy probably has less leeway today than it did in 1998 to react to possible real effects of credit market turbulence with interest rate cuts without compromising price stability,'' Swiss central bank governing board member Philipp Hildebrand said Sept. 24.
Inflation accelerated above the ECB's ceiling in September, rising at a 2.1 percent year-over-year rate, the most in 13 months, official Eurostat figures showed last week.
Thomas Mayer, co-chief economist at Deutsche Bank AG in London, says even if inflation risks are sustained they will eventually run second to weaker expansion as the top concern.
``Inflation will remain relatively sticky, but in the end central banks will have to respond to the growth outlook,'' he says.
To contact the reporters on this story: Rich Miller in Washington rmiller28@bloomberg.net Simon Kennedy in Paris at skennedy4@bloomberg.net
Last Updated: September 30, 2007 19:12 EDT
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Pimco's Gross Says Housing Will Drive Monetary Policy for Years
By Elizabeth Stanton
Oct. 1 (Bloomberg) -- Bill Gross, manager of the world's biggest bond fund, said falling home prices will be the main driver of U.S. monetary policy for ``several years,'' and repeated his forecast the Federal Reserve will lower the federal funds rate to at least 3.75 percent in the coming year.
While the rate cuts may occur this year, it's more likely they will be delayed by mixed signals about the economy, Gross wrote in a report published on the Web site of his firm, Pacific Investment Management Co. The Fed on Sept. 18 lowered its target for the overnight lending rate between banks for the first time since June 2003, to 4.75 percent from 5.25 percent.
``The downward path of home prices, however, will dominate Fed policy over the next several years as will the lingering unwind of related financial structures and derivatives that have yet to be discovered by the public, and marked to market'' by their holders, Gross wrote.
Gross is chief investment officer at Pimco in Newport Beach, California. The firm, a unit of Munich-based Allianz SE, oversees $692.7 billion, including the $104.4 billion Pimco Total Return Fund.
To contact the reporter on this story: Elizabeth Stanton in New York at estanton@bloomberg.net
Last Updated: October 1, 2007 08:58 EDT
