Interest Rate Views: November 2008 - OCBC Wealth Management

Central banks likely to cut rates further

28 October 2008

The Federal Reserve led the charge in October by coordinating a rate cut along with the ECB, BOE, and other major central banks, in a bid to put a floor on a crisis that threatened the existence of the banking system and to encourage liquidity in a bone-dry credit environment. The Fed convened an emergency session with its major counterparts in other regions and cut its own benchmark Fed funds rate by 50 basis points to 1.5 per cent.

Looking ahead, we consider it likely that the Fed's benchmark rate may be lowered further as it becomes painfully apparent that there is a need for more measures to jumpstart the ailing economy.

Euro-zone

We highlighted last month that Trichet and his colleagues would soon find it necessary to loosen monetary policy, given the poor state of the European economy and the world at large. Their hands were certainly forced in October, as credit conditions worsened sharply, compelling the ECB to move with the Fed and conduct a joint rate cut.

There is scope for the ECB to continue easing policy as the global slowdown makes its way through Europe. However, we are concerned as to whether the central bank can find consensus quickly enough among its member nations. Nevertheless, we should see the Euro benchmark rate at 3 per cent by year-end.

U.K.

The U.K.'s absolute inflation rate continues to stay elevated, but it is clear to observers that price pressures are not the focus any more. The BOE cut its benchmark rate by 50 bps, in conjunction with the other major central banks in October. We take this as a sign of more to come, as Governor Mervyn King and his colleagues work to keep the economy from stalling.

We forecast an easing to 4 per cent or below by the end of 2009.

Australia

The RBA surprised analysts by slashing its benchmark cash rate by a full percentage point in October, beating even the most dovish of estimates. In accompanying comments, Governor Stevens noted that an unusually strong response was needed, given the extreme problems being faced in the credit space. On the other hand, he noted also that the large cut should not be considered as the start of a trend, signalling instead that this would be a one-off move.

While 1 per cent cuts should not be the norm going forward, we expect that the central bank will continue to take an easing bias, and will likely lop off another 150 bps over the next few months to bring the cash rate down to 4.5 per cent.

New Zealand dollar

The RBNZ cut its benchmark rate by 100 basis points in late October, following in the RBA's footsteps, in the hope that lower costs will be passed down to consumers in a tangible way. Governor Bollard, in his accompanying comments, noted that the market should not expect 1 per cent cuts to be the norm, but indicated preparedness to further easing if the situation requires it.

There is room for the RBNZ to cut rates further, as New Zealand has one of the highest benchmark rates in the developed world. We expect to see rates closer to 5 per cent by the end of 2008.

Japanese Yen

The Bank of Japan decided to hold rates steady in October, choosing not to follow the coordinated action by the other major central banks. The Japanese central bank has instead been providing liquidity and support through open market operations, reasoning that its benchmark interest rate was already very low at 0.5 per cent, and there was not much room to cut further. Nevertheless, the prospects for a 25 basis points cut cannot be discounted, depending on the depth of the global economic slowdown, and it impacts the Japanese economy.

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