Goldilocks or Signs of Stagflation?
Currency Overlay Report: 8/31/06
ssga.com
By John M. Balder, Vice President, Currency
Overview
Central banks across the globe raised rates during the month of August as inflationary pressures continued to mount, despite increasing evidence that global growth had slowed from its rapid pace in the first half of 2006. The ECB, BOE, Reserve Bank of Australia, Norges Bank and Riksbank each hiked rates by 25 basis points during the month.
The BOJ and a “dovish” Federal Reserve held policy steady, given the heightened state of uncertainty in both countries about future economic growth (and the state of the housing market in the U.S.).
Currency statistics for August 2006:
US
The Fed did not hike interest rates at its August meeting. The release of the minutes from the meeting suggested that the FOMC was concerned about signs of economic weakness, associated in particular with the housing sector. While FOMC members remained concerned about potential inflationary pressures, they also expressed concerns about risks to economic growth.
Economic data released during the month did not paint a clear picture, as US GDP growth for Q2 was revised upward from 2.5% to 2.9% and immediate inflationary pressures remained quiescent, yet consumer confidence deteriorated. At month-end, the market expected the Fed to remain on hold for the rest of the year.
Europe
The ECB tightened rates by 25 basis points to 3.0% at its meeting on August 3. In a press conference at month-end, ECB President Trichet used the words “strong vigilance” to reiterate the ECB's hawkish stance. Rates are expected to increase by 25 basis points in October and the market expects rates to end the year at 3.5%. GDP growth in the first half of 2006 averaged a robust 3.5% across Europe, but is expected to slow modestly in the second half of the year.
Japan
The Bank of Japan remained on hold at its meeting in early August. The subsequent release of CPI data (up 0.2% versus market expectation of 0.5%) indicated that the BOJ might have acted prematurely in shifting away from its zero-interest rate policy in July. Yet, the economic data have been mixed in Japan and statements by the BOJ have been “hawkish” relative to the market.
Other Developed Economies
* Canada: Weaker than expected real GDP growth of 2% in Q2 was offset by stronger domestic demand in Canada as the BOC, uniquely within the G-10, has remained on hold since spring. Further complicating life for the BOC, inflationary pressures have accelerated over the summer. Markets have priced in no additional rate hikes before year-end.
* UK: The BOE caught markets by surprise in choosing to hike interest rates at its meeting on August 3. With the housing sector and consumer spending apparently reaccelerating, the BOE decision suggests continued concern about inflationary pressures. The markets have priced in a fairly high probability of another 25 basis point move before year-end, and the GBP strengthened versus all other developed market currencies in August.
* Australia and New Zealand: As expected, the RBA hiked interest rates by 25 basis points on August 2. Economic momentum and inflationary pressures continued to accelerate in Australia. The RBNZ remained on hold during August as concerns persisted about the excessive size of the current account deficit.
* Scandinavia: The Norges Bank and Riksbank both hiked rates by 25 basis points in August. Inflation differentials currently favor the NOK and the Riksbank is expected to hike again, should inflationary pressures accelerate. The market expects both central banks to raise rates again before year-end.
* Switzerland: The SNB is expected to hike rates by 25 basis points at its meeting on September 14th. Measures of core CPI inflation remain well within the 2% range in Switzerland with growth in 2006 expected to fall between 2.5% and 3.0%.
This material is for your private information. The views expressed in this commentary are the views of John Balder of SSgA's Global Currency Group through the period ended August 31, 2006 and are subject to change based on market and other conditions. The opinions expressed may differ from those of other SSgA investment groups that use different investment philosophies. The information we provide does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. We encourage you to consult your tax or financial advisor. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information. Past performance is no guarantee of future results.
Posted On: September 07, 2006
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