Central banks are keeping key interest rates at record low levels
- The emphasis to keep rates low would encourage investors to demand risky assets
Many central banks were busy over the past week, making decision on their monetary policies. The main role of a central bank is to maintain price stability and often, that ties in with the state of economy so monetary policy becomes a tool to deal with economic cycle.
While the extremely lax monetary policy (along with many other measures) has borne fruit in helping global economy recover, it is encouraging to note that many central banks, most notably the Federal Reserve, are keeping benchmark interest rates unchanged and not risking rates hikes prematurely. We believe that low interest rates would help to stimulate economic growth and support the prices of financial assets.
30 Oct 09: Bank of Japan Maintains Rate at 0.1%
Bank of Japan (BOJ) kept rates unchanged at 0.1% and said that the bank will maintain extremely accommodative financial environment for some time by holding interest rates at their current low levels and by providing ample funds to meet demand in financial markets. On the other hand, the temporary measures such as the outright purchase of commercial papers and corporate bonds since 2008 would be withdrawn starting end of 2009 as BOJ noted that the Japan’s financial environment has shown signs of improvement.
3 Nov 09: Reserve Bank of Australia hiked rates by 0.25% to 3.5%
Reserve Bank of Australia (RBA) was the only central bank in the developed nations to start raising rates. The first rate rise was implemented on 6 October 09 for which the market reacted positively because they are encouraged by the RBA’s confidence in the economy. A second hike was implemented this week on 3 November. RBA expects the Australian economy to increase 1.75% for 2009, 3 times faster than the 0.5% gain forecast 3 months ago. In 2010, the economy is expected to grow 3.25%.
4 Nov 09: Bank of Indonesia Maintains Rate at 6.5%
Bank of Indonesia (BOI) maintained its reference rate at 6.5%, the lowest level since the reference rate was introduced in May 2005. Inflation unexpectedly slowed to a nine-year low of 2.57% in October. While prices may start to climb in coming months due to a low base, BOI believes that inflationary risk is not high enough to warrant a rate hike at this moment.
4 Nov 09: Federal Reserve Maintains Target Range of 0% 0.25% for Fed Funds Rate
The Federal Reserve (Fed) is maintaining its target of near-zero interest rates for the Fed Funds Rate. The Fed noted that economic activity has continued to pick up with increase in activity in the housing sector but household spending would still be weak on ongoing job losses, sluggish income growth, lower housing wealth and tight credit. The Fed expects that while economy is likely to remain weak for a time, the various measures taken so far to stabilize the financial markets coupled with monetary and fiscal stimulus would support a strengthening economy.
5 Nov 09: Bank of England Maintains Rate at A Record Low of 0.5%
The Bank of England (BOE) maintained its key interest rate at a record low 0.5% and decided to increase the purchase of United Kingdom gilts (government bonds) by 25 billion pounds. While the quantum is smaller than economists’ expectation, the decision to continue with the quantitative easing should help the economy return to growth.
5 Nov 09: European Central Bank Maintains at Key Rates at A Record Low of 1%
European central bank (ECB) left key interest rates unchanged at 1%, believing that current rates are appropriate even though inflation is expected to turn positive in coming months. ECB acknowledges that economic activity has improved in the second half of the year and expects the euro area economy to recover at a gradual pace in 2010 despite the outlook being subject to high uncertainty. On the downside, ECB is going to phase out the liquidity measures in a timely and gradual fashion as they reckon that there is less need for such liquidity.
Maintaining low interest rates are supportive of economic growth and asset prices
Many central banks have kept their benchmark interest rates unchanged and some have signaled that the low rates may be maintained for an extended period of time. Low interest rates are beneficial for the economy as businesses and consumers would be more likely to borrow and spend, stimulating economic growth. The emphasis to keep rates low is a stimulus for financial markets as investors would see less incentive to keep it in safe assets such as government bonds and turn to more risky assets, including corporate bonds and equities for higher returns.
Worries over premature rate hikes may have contributed to the heightened volatilities for equity markets in the past week. However, with the central banks determined to keep rates low amidst improving economic data, risk appetite would soon return. We remain optimistic on the recovery of equity markets.