Era of Low Rates Around the Globe May Soon Be Over
Banks From Japan to Europe Ponder Tightening With Fed;
Signs of Inflation Pop Up
By GREG IP in Washington, SEBASTIAN MOFFETT in Tokyo and JON E. HILSENRATH in New York
Staff Reporters of THE WALL STREET JOURNAL
October 13, 2005; Page A1
In Japan, a fish-products manufacturer has raised prices 10% thanks to booming overseas sales and costlier boat fuel. In Germany, the national railway plans to raise some fares more than 4%. In one Chinese city, lines formed around grocery stores after a local supplier said it would lift salt prices as much as 50%. And in North America, luxury hotel chains are jacking up room rates.
As signs of inflation, spurred in part by soaring energy prices, surface around the world, central banks are signaling that the era of unusually cheap credit is coming to an end. Implications for markets and the world economy are significant: Investors may retreat from risky assets and air could leak out of the global housing boom. A recession seems unlikely but can't be ruled out since world central bankers seem determined to raise rates as much as needed to keep inflation low.
The Bank of Japan, by early next year, may end its policy of cramming extra cash into the banking system in hopes of boosting lending, governor Toshihiko Fukui indicated yesterday. Japanese interest rates, now effectively zero, may start to rise later in the year. Last week, the European Central Bank strongly hinted it was leaning toward raising rates, which have been flat for over two years. The Federal Reserve has been raising rates for 15 months now, and minutes to its Sept. 20 meeting released Tuesday suggest it will raise them further. South Korea's central bank raised interest rates for the first time in three years on Tuesday, in part because of higher U.S. rates, which threatened to draw capital away from Korea.
Japanese and European central bankers are so far only talking about raising rates. A reversal in oil prices or renewed economic slump could keep them on hold. But if talk soon turns to action, it would be "the first full-bodied global monetary tightening" since 1988-89, says Bruce Kasman, economist at J.P. Morgan Chase.
The mere expectation that central banks will tighten the cash spigots has prompted investors to trim their appetites for risk. The Dow Jones Industrial Average has fallen 4% since mid-September while the Dow Jones World Stock Index excluding the U.S. has fallen 2%. Yields on speculative corporate and emerging-market bonds, denominated in dollars, have edged up relative to those on safe U.S. Treasury bonds as investors demand more return to compensate for the risk of the investment.
"We're going to be going through the process of unwinding the excesses of the last three or four years," predicts Michael Mussa, a scholar at the Institute for International Economics, a Washington think tank. Around the world, home building and consumer spending -- fueled, in part, by housing wealth -- will slow, he says: "We are likely to get a significant slowing in growth, but not a world-wide recession."
Since 1990, inflation in the advanced countries has fallen to 2.2% from 5.1%, according to the International Monetary Fund. In the world as a whole, it has tumbled to less than 4% from 26%. The IMF expects both measures to edge lower next year. Nonetheless, "central banks are worried about losing the credibility that they have built up over a number of years," says Raghuram Rajan, the IMF's chief economist.
Inflation rose sharply in the 1970s as oil prices soared and many central banks were reluctant to pay the price in lost economic growth of pushing inflation lower. Those countries finally bit the bullet in the early 1980s instead when dramatically tighter monetary policy triggered deep recessions. "The lesson from the 1970s is that if central banks...let the inflation genie out of the bottle, it is much harder to get it back in and you sacrifice far more growth" to do so, Mr. Rajan says.
That suggests central bankers will err on the side of higher rather than lower interest rates. Mr. Rajan says a slowdown could "happen smoothly or abruptly." If it happens abruptly, "then I think we have a problem."
Not all countries are bent on raising rates. Australia and Britain were among the first countries to raise theirs. Now, with local housing markets cooling and economies slowing, Australia has stopped raising rates and Britain has cut them.
Mix of Rule Changes
China does not appear ready to raise rates even though many economists think it should. In Nanchang, shoppers lined up outside grocery stores to buy salt after a local supplier said it would lift its prices by as much as half to pay for a switch to plastic packaging from paper. Rather than use interest rates, China has fought inflation with a mix of rule changes, industry subsidies and price controls. It has responded with government payouts for taxi drivers threatening to strike over rising gasoline prices. The authorities shelved plans to raise the entrance fee at Beijing's Forbidden City to $12.50 from $7.50 because of public opposition.
While the reasons central banks are becoming more hawkish vary, two major factors are common. First is the price of oil, which has soared almost 50% this year, to $64 a barrel. Central bankers are content to let higher energy costs temporarily boost inflation but don't want to see them become more widely embedded in prices and wages.
The second is that easy monetary policy has done what it was designed to do: heal the world economy after a series of shocks and structural drags, ranging from Japan's weakened banking system to the collapse of the global information-technology investment bubble. Low interest rates helped corporations reduce their debt burdens and interest costs, encouraged consumers to buy homes and cars, and boosted house and stock prices, making consumers wealthier and more willing to spend.
But leaving rates low as economies return to full strength raises the risk that buoyant demand will outstrip the capacity of businesses to crank out goods and services. The result would be bottlenecks and higher prices. Thus, central banks want to get rates back to normal levels.
The urge to normalize is most obvious in Japan where prices since 1999 have actually declined. This "deflation" is a legacy of the economic stagnation that began when its property and stock bubbles burst in the early 1990s. Borrowers could not repay loans taken out to invest in stocks and land. Stuck with a mountain of bad loans, banks were reluctant to make new ones. Over-investment during the 1980s had also left Japanese corporations with too many factories and staff, putting downward pressure on prices.
Radical Tactic
In 2001 the Bank of Japan, having already cut short-term rates to almost zero, adopted a radical new tactic: pumping extra cash into the nation's flailing banks in hopes they would use it to extend loans.
These steps may be working. Banks have cleaned up their bad loans, corporations have rid themselves of unneeded capacity and the economy is growing. Japan's closely watched corporate goods price index, after declining from 1998 to 2003, rose last year and most months this year. Bridgestone Corp., Japan's largest tire maker, began in 2004 to raise the prices of selected products because of the higher cost of rubber and oil.
Kibun Foods Inc., a maker of fish products, in August raised prices about 10% on fish-paste products, either with outright price increases or shrunken packages. A spokeswoman credits, among other things, demand from U.S. and European consumers shunning poultry because of avian flu and costlier fuel for fishing boats.
The Bank of Japan says it will maintain its policy of forcing cash into the banks until consumer prices, excluding fresh food, stabilize. Mr. Fukui, the central bank governor, suggested yesterday he expects that test to be met by next year. The odds are rising that, as soon as April, the Bank of Japan will stop pumping excess cash into the banking system, he said. Private economists predict it will begin to nudge interest rates higher in the summer. Japanese 10-year government bond yields have risen in anticipation, hitting an 11-month high yesterday before dropping back to 1.54%.
The Bank of Japan's actions are expected to be gradual enough to mute the economic impact, but they could still roil financial markets. One reason: Some investors have used cheap, yen-denominated loans to finance risky investments.
In the countries that use the euro, economic growth remains sluggish, largely because of stagnation in Germany. As a result, the European Central Bank has kept its target for short-term rates at 2% for more than two years. But lately the ECB has concluded higher commodity prices will be putting upward pressure on inflation over the long term. It also is worried that unions will respond with higher wage demands.
Emerging Pressures
In Germany, energy-induced inflation pressures are emerging. As of Dec. 11, German railway operator Deutsche Bahn will charge 2.9% more for second-class tickets and over 4% more for first class. Energy prices are also working their way into general goods. Stadtb, a chain of more than 100 bakeries in northern Germany, recently began charging 3 or 4 European cents more, or as much 10%, for a single bread roll. It blames delivery-related gasoline costs and rising energy costs in shops and bakeries. Such incidents may be nurturing an inflationary mindset. A recent study from the nation's statistics office shows that the public feels inflation is more than 7% when in fact it's been under 2%.
Last week ECB President Jean-Claude Trichet said that while the current rate was "still appropriate" the bank would tighten the instant it sees higher prices emerging. Markets expect the first increase in March. Higher rates would likely cool buoyant housing markets across Europe and slow fast-growing Spain and Ireland, while endangering Germany's fledgling recovery.
In the U.S., as in Europe, higher energy prices, aggravated by supply interruptions from hurricanes, threaten to seep into broader price measures. In a September survey of small businesses by the National Federation of Independent Business, 32% of business owners reported raising prices last month, compared with 8% who cut prices. And as in Japan, the U.S. economy has largely healed after the trauma of a collapsed investment and stock bubble. Marriott International Inc. said North American room rates rose 7.9% in its third fiscal quarter ended Sept. 9 from a year earlier thanks to higher occupancy and the high cost of building new hotels, which limits supply.
The Fed has raised its short-term rate target from a 46-year low of 1% last summer to 3.75% now. The central bank has signaled it plans to keep going. Its actions so far have done little to slow the economy, in particular housing. That's largely because long-term bond yields, which are set by markets and influence mortgage rates, have remained unusually low in the U.S. and around the world. Precisely why is a mystery.
One possibility is that the supply of capital, or global savings, is high right now, while the demand for it -- investment -- is low<?i>. Thus, interest rates, the price of capital, have fallen. That is not likely to change much soon.
Another is that the prolonged period of easy global monetary policy has forced investors to accept lower long-term bond yields, especially in the U.S. If so, a move to tighter global monetary policy could finally produce the long-predicted rise in bond yields and slowing in housing, both in the U.S. and elsewhere.
--G. Thomas Sims in Frankfurt and James T. Areddy in Shanghai contributed to this article
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