New Zealand Surprises with a Rate Increase

Good day… Chuck was scheduled to be back in today, but he emailed me last night to let me know his hip is still giving him trouble, so you’re stuck with me. It was a pretty slow day in the currency markets yesterday, as the ECB move was widely expected, and Trichet’s comments weren’t market moving. The ECB president said, “acting in a firm and timely manner to ensure price stability in the medium term is warranted.” The markets needed to hear a more hawkish Trichet, so the euro (EUR) range traded for most of the day hovering just below 1.35. While Trichet didn’t signal that another rate hike is imminent, the markets have priced in at least two more rate increases this year.

In a move that surprised the markets, New Zealand raised interest rates to a record 8% due to increasing inflationary pressures. Housing demand and consumer spending continue to cause the central bank to keep a vigilant eye on inflation. Dairy prices have surged 60 percent in the past six months, boosting farmer’s incomes. Bollard said nothing to restrain the currency, and the bias seems to be for more interest rate increases in the future. The kiwi (NZD) rose to a 22 year high after the surprise interest rate increase.

With two central banks reporting rate increases yesterday, the markets’ attention moved to the BOE, which was scheduled to announce their rate decision this morning. In a move contrary to our thoughts, the BOE left rates unchanged at a six-year high, giving four previous increases time to slow inflation. As I wrote yesterday, this was a perfect time for the bank to make a statement by increasing rates when everyone expected them not to.

Unfortunately it looks like England’s Monetary Policy Committee decided against a hike on the grounds that they did not want to surprise the markets. The non-move will only serve to put more pressure on the BOE for a larger move in the third quarter. Inflation has held above the 2% target for a year, and the bank’s own forecasts show higher interest rates are needed to rein in prices.

Chuck and I aren’t alone in our thoughts on the BOE’s move, as shown by the comments of David Brown, of Bear Stearns:

“The Bank of England have sat on their hands this month, but the writing is definitely on the wall for a hike in July. The bank left the job half-finished in May and have ended up behind the curve on monetary fundamentals. A bigger monetary response is now needed and policy makers remain under pressure to catch up quickly. Inflation is too high and monetary expansion is running far too fast. The tightening bias is still intact.”

The pound sterling (GBP) fell slightly to trade back below 1.99, but is still within the upward trading pattern it has established over the past month. I still expect sterling to challenge the $2.00 figure in the near future.

So two of the three central banks that had rate decisions in the past two days saw inflationary pressures building and therefore moved interest rates up. So where does that leave our own Fed regarding interest rates? Data released in the United States yesterday morning illustrates the very troubled waters the FOMC has steered our economy into.

Reports showed that U.S. worker productivity slowed while labor costs climbed. President Bush’s economic advisors also cut their forecast for U.S. growth in 2007, reflecting a slower economy in the first quarter of the year. So the U.S. economy continues to slow while inflation pressures continue to build.

Rising energy and commodity prices will continue to feed back into consumer prices keeping the Fed from lowering interest rates. But the US economy is going to continue to slow down and may slip into negative growth if/when the housing crunch filters back down into the general economy. So what can the FOMC do but sit on the sidelines and hope the U.S. economy somehow finds its own way out of these dangerous waters. Look for Bernanke and his buddies to keep rates unchanged at their meeting the end of this month.

The big movers overnight were the kiwi and Australian dollar (AUD). As I reported above, the kiwi moved to a 22 year high on the surprise rate move. The Australian dollar moved up after a report showed employment increased four times as much as expected in May, worsening a labor shortage that will likely force the central bank to raise interest rates to ward off inflation. The jobless rate in Australia dropped to 4.2%, the lowest in almost 33 years. Both the kiwi and Aussie dollar central banks will likely continue to raise rates through the end of 2007, all but assuring continued strength in these two currencies.

The Indian rupee (INR) has dropped the past two days on speculation that capital inflows from abroad into stocks will slow after the benchmark index added to its biggest decline in more than a month yesterday. The sell off in the stock index suggests overseas investors may be looking to cash in some of their investments, which could curb demand for the rupee. This pull back should be short lived, as India is the second-fastest growing major economy behind China.

Currencies today: A$ .8466, kiwi .7555, C$ .9442, euro 1.3481, sterling 1.9864, Swiss .8176, ISK 62.73, rand 7.19, krone 5.9924, SEK 6.9145, forint 187.76, zloty 2.8433, koruna 21.08, yen 121.34, sing 1.5341, HKD 7.8130, INR 40.73, China 7.6505, pesos 10.8566, dollar index 82.09, Silver $13.69, and Gold… $670.45

That’s it for today… We will see the weekly jobs data released this morning along with consumer credit. The currency markets will likely be focusing on tomorrow’s release of the trade balance, which should continue at near record levels. Congratulations to the Anaheim Ducks on their Stanley Cup! Hope everyone has a great Thursday.

Chris GaffneyJune 07, 2007