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Boring Ben! - Views on News from Equitymaster
 
 
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  • May 10, 2007

    Boring Ben!

    In his seventeenth months at helm at the US central bank, the Federal Reserve, governor Ben Bernanke has inculcated this habit of boring the markets, the economists and all those experts with his usual stuff about inflation and interest rates. This time is no different either. To be true, he has been forced by the behaviour of the US housing and stock markets as also the core economy in his decisions to keep the short-term rates steady. Led by him, the US Federal Reserve has kept the Fed fund rate (equivalent to reverse repo rate in India) at 5.25% in its monetary policy meeting yesterday.

    In a statement released yesterday, which reasoned why the Fed has kept the rates stable, it was indicated that the US economic growth has slowed in the first part of this year (2007) and that the 'adjustment in the housing sector is ongoing'. The central bank also maintained its concerns regarding inflation, which has stayed at higher levels.

    In stating that 'although inflation pressures seem likely to moderate over time, the high level of resource utilisation has the potential to sustain those pressures', the Fed has indicated that it shall closely keep a watch on the US unemployment rate, which has not increased despite the slowing down of the economy. Readers would do well to note that a low level of unemployment (or high level of employment) leads to more people being part of the consuming class, thus chasing goods and services produced in the economy and consequently leading to inflation, ceteris paribus (other things remaining constant).

    As for the future, the Fed has indicated that 'future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth'. This is a tone that has been mimicked by our own Dr. Reddy (the RBI governor) in recent times as he fights to contain inflationary pressure on the back of supply side constraints. As part of its battle for price stability, the RBI has raised its key interest rates like repo (rate at which the RBI lends money to banks for short term) and CRR (Cash Reserve Ratio) a number of times in the past few months. While inflation has shown signs of softening, there has not been a meaningful impact of rising rates on the same.

    In recent times, the RBI has had to face another dilemma, this time on account of robust foreign inflows. As the dollars continue to flow in, the RBI is keeping on the sidelines, as otherwise, if it were to buy these dollars and infuse rupees into the system, it would have had a negating impact on the liquidity curb brought about by tightening interest rates. Now, since the RBI is not buying dollars, the effect is seen in the rupee which has appreciated from near RS 45/US$ levels to the current Rs 40/US$ levels. This has been a huge negative for exporters as they get lesser rupees for each US dollar of revenue that they convert, thus making exports uncompetitive. Sectors like software, pharma, textiles and, to an extent, capital goods, which have been among the biggest exporters from the country, are now facing the heat on account of the appreciating rupee against the US dollar.

    The dilemma continues - for the RBI, as also for most of the central bankers around the world. And the irony is that stock markets across regions do not seem immensely worried about the uncertainty that face these central banks. The Dow is rising, so is the Nikkei, so is the FTSE and so is the Sensex!

     

     

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