Tuesday, January 22, 2008

Thx Wolfgang Munchau (fg)

Here is an excellent comment on the FED's rate cut. I have nothing to add.
Today's 75bp rate cut by Helicopter Ben reminds me of an FT column I wrote in 2000, when I accused the Fed of targeting the Nasdaq. I remember I got a very angry response from a now former colleague who thought I was grossly unfair. But I don't think I was then. It is very clear that Fed was then - and is now - extremely concerned about a stock market correction. The timing, and the unprecedented scale of this rate cut, clearly suggests that this decision was intended as a signal to the financial market first and foremost. Of course, one can always the defend the Fed rate cut on the grounds that it is designed to prop up a sinking economy, but then again, if that had been the true intention, they could have done it last week. The Fed does not tolerate a protracted fall in US share prices. This is not just the Bernanke put. This is a central bank that actually tries to target the stock market in a very direct way.

What this is going to do to inflation is now the big question. I remain extremely pessimistic, and would now revise my expectations for medium-term US inflation up sharply - that is beyond the recession. The gold also price shot up on the news. Investors have short-term treasuries and sold long-term treasuries - which suggests that those parts of the market are also concerned. Of course, I cannot exclude the possibility that the downturn is so severe as to produce a global recession, plus disinflation. But they would rise immediate after economic activity picks up. The concern is not about short-term inflation, but about longer term inflationary trends. And these are clearly exacerbated by today's rate cuts, which are almost certain to be followed by another rate cut at the end of January.

What is the European response? A revealing statement ahead of the Fed rate cut came from Jurgen Stark of the ECB who said in Brussels, according to Reuters: "We have seen some excesses in the past and we are now in an ongoing process of market correction. We should not dramatise the situation." Not dramatise the situation is another way of saying: not react to it. There are other response from other central bankers, including from Vitor Constancio, governor of the Bank of Portugal, who express concerned that the US slowdown might affect the euro area. There are undoubtedly ECB governors who would want the ECB to react by cutting rates, but the ECB's lethargic policy process is now working in the other directions. Stark and Axel Weber of the Bundesbank in particular did not get the rate rise they wanted, but they sure can stop the rate cut. The ECB majority will probably not go against the two Germans on the board. And I suspect Trichet would probably not want to either. Also, the ECB is keen to avoid the impression that it is following the Fed. So we may be stuck at 4% for longer than some analysts currently predict. The outlook has not changed. In a separate article in our ECB Watch column, we are going to take a hard look at the longer term interest rate outlook.