Central banks to decide on rates

Five central banks will decide on interest rates this week with only Sweden likely to hike rates on Friday by 25bps to 3.75%, while the Bank of Canada (BOC) and the Reserve Bank of Australia (RBA) meeting on Wednesday and the Bank of England (BOE) and the European Central Bank (ECB) meeting on Thursday are expected to leave rates unchanged.

However, monetary statements, especially by the BOC and the ECB, will be looked at closely in respect of their judgement of the US sub-prime crisis and potential spillover effects with most analysts expecting a rate cut by the Fed policy makers meeting on September 18.

Newswires quoted a “senior ECB source” as saying on Friday that the ECB “could postpone for one month”, but that the “monetary policy retains a tightening bias”. A similar line was echoed in the FT, suggesting the ECB will deliver a hawkish press statement on Thursday.

However, analysts at BNP Paribas are not convinced that ECB hawkishness will lead the euro higher, but might in fact become a euro negative if the market perceives the ECB as being out of step with global economic reality.

While Fed Chairman Ben Bernanke left the rate cut door wide open he did not leave the impression of being ready to act ahead of the curve. It was to be expected that he would emphasise that Fed policy was not to bail out greedy investors, but he added that the economic impact of the recent turmoil needs to be observed.

Bernanke said that the Fed would act as required by economic circumstances does not sound like somebody accepting financial markets as a leading indicator. Of interest is also his suggestion that the US housing market has become less sensitive to short-term rates, implicitly indicating that the Fed recognises recent spread widening as a big threat to the housing market.

Hence, policy measures must be designed to reduce credit spreads. All this looks like a justification of the recent ‘targeted measures’ approach used by the Fed, but not like a central bank willing to operate ahead of the expectations curve.

Nonetheless, equity market investors have remained optimistic, but the question remains for how long.