As part of the ‘calibrated exit’ from expansionary monetary policy, the Reserve Bank of India unexpectedly increased the repo rate to 5.5 per cent and the reverse repo rate to 4.0 per cent. The central bank also extended liquidity support already in place for commercial banks:
i) The additional liquidity support to scheduled commercial banks under the LAF to the extent of up to 0.5 per cent of their net demand and time liabilities (NDTL) currently set to expire on July 2, 2010 is now extended up to July 16, 2010. For any shortfall in maintenance of statutory liquidity ratio (SLR) arising out of availment of this facility, banks may seek waiver of penal interest purely as an ad hoc measure.
The Reserve Bank of India has increased the repo and reverse repo rates by 25bp, taking them to 5.5 and 4 per cent, respectively. The principal motivation was inflation:
The developments on the inflation front … raise several concerns. Overall, WPI inflation increased to 10.2 per cent in May 2010, up from 9.6 per cent in April 2010. Food price inflation and consumer price inflation remain at elevated levels…. Significantly, two-thirds of WPI inflation in May 2010 was contributed by non-food items, suggesting that inflation is now very much generalised and that demand-side pressures are evident.
Goldman Sachs economists have been among the more bearish forecasters on Wall Street, seeing an incredibly sluggish recovery with inflation falling close to zero and unemployment hovering around 10 per cent through the end of next year.
So last night, they released a 32-page paper taking their view to its most logical conclusion. If they ran the Federal Reserve, they might well be contemplating further policy accommodation. “In the short term our model combined with GS economic projections implies that further macroeconomic easing would be optimal to counter stubbornly high unemployment and falling inflation. With the funds rate already at zero bound, additional stimulus would need to come through fiscal easing and/or renewed asset purchases.”
The GS paper goes on to say, to no great surprise, that if the additional easing is carried out on the fiscal side, “it should be paired with legislation that brings the federal budget back onto a sustainable path via a combination of spending cuts and tax increases.”
Instead, if the focus is on asset purchases, GS warns that the Fed would have to be “realistic” about the outcome, since there is a potential problem of diminishing returns.
Kevin Warsh, a governor at the Federal Reserve, has just delivered a very interesting speech in Atlanta.
His main point is that the Fed could start selling mortgage assets it bought to sustain the housing market during the crisis independently of its moves to raise interest rates, putting him squarely in the camp of inflation hawks on the Federal open market committee. Ben Bernanke, Fed chairman, has suggested that any asset sales should come only after monetary policy tightening underway, but Mr Warsh seems to disagree. “Any sale of assets need not signal that policy rates are soon moving higher. Our policy tools can indeed be used independently. I would note that the Fed successfully communicated and demonstrated its ability to exit from most of its extraordinary liquidity facilities over late 2009 and early 2010, even as it continued its policy of extraordinary accommodation,” he said.
The Fed governor, a former Morgan Stanley investment banker and George W. Bush administration official, also attempted to quash the rising talk that the Fed might actually start buying assets again in response to continued weakness in the housing sector and the sluggish recovery, saying that such a move “should be subject to strict scrutiny”.
This does not look good, says David Beckworth: the US market expects aggregate demand to fall, and if the Fed does not act to stabilise the fall in spending, it will act as an effective tightening of monetary policy.
His logic? Markets’ expectations of inflation fell in the first half of this year as shown by the falling yield spread between inflation-protected and regular bonds (see chart). Productivity growth – which could have explained it – also appears to be falling. “That leaves us with one troubling possibility: the market is expecting aggregate demand to decline going forward.”
Even though many economists have pushed back their expectations of the first interest rate hike by the Federal Reserve, the debate rages on about the tools the central bank should eventually use to tighten monetary policy.
In a research paper out today, Glenn Rudebusch, senior vice-president at the San Francisco Fed, makes a compelling case for not rushing to shrink the Fed’s $2,300bn-plus balance sheet, a move that some more hawkish officials have been pushing for early in the tightening cycle in order to contain inflation.
Overall, Mr Rudebusch concludes that since many predict the US economy will take “years” to return to full employment and inflation will stay low, it will take “a significant amount of time” for the Fed to exit from its current easy money monetary policy stance.
But some of his most interesting points
Today’s Fed minutes offered some crunchy details on the debate within the US central bank over asset sales. And it looks like Ben Bernanke is winning the argument.
Months ago the Fed chairman said the central bank should consider selling the $1,000bn-plus portfolio mortgage-backed securities and agency debt accumulated during the recession, but only after the recovery was entrenched and monetary policy tightening had begun.
In terms of monetary policy, the message from senior Federal Reserve officials today was not to read too much into their pledge of keeping interest rates low for an “extended period”.
In separate speeches, Donald Kohn, the vice-chairman, and Narayana Kocherlakota, president of the Minneapolis Fed, made clear that the phrase could mean pretty much anything under the sun, since the timing of any policy tightening would be determined by the health of the economy.
The 30-year fixed rate mortgage rate in the US fell this week to a five month low of 4.93 per cent, according to Freddie Mac.
Mortgage rates had spiked above 5.20 per cent early last month, just after the Federal Reserve ended its $1.250bn plan hatched during the financial crisis to purchase mortgage-backed securities and support the housing market.
If we get a Conservative/Liberal Democrat government in the next day or so, pity the UK Treasury. It had been preparing to tell the new chancellor that the public finances were in a terrible shape and new tax increases were extremely difficult to avoid. That pep talk seems to have become quite a bit more difficult.
There was no doubt at the gathering of central bankers here in Zurich today that Britain was the big unanswered question when it came to the next big global risk.