Awaiting Rate Cuts Wednesday in Norway and the United States

October 28, 2008

When the Norges Bank cut rates on October 15th for the first time since March 2004, a reduction of 50 basis points to 5.25%, hints were dropped that more monetary relief could be required, and officials made a point to underscore that a planned monetary policy meeting on October 29th would go ahead as scheduled and result in a fresh review of economic conditions and prospects. There had previously been rate increases this year of 25 bps each on April 23rd and June 25th, and the about-face earlier this month was a response to a spreading banking crisis, declining and more costly capital in Norway, reduced inflationary forces, and a need for preemptive actions against worst-case scenarios. A quarterly central bank survey released today found credit standards to have tightened in 3Q08 for both households and businesses. Each of these groups is looking for even more restrictive conditions during the final quarter. That survey seals the likelihood of a rate reduction tomorrow. With the benchmark level of 5.25% still retaining a 5-handle, a reduction of more than 25 basis points makes greater sense than a move of only a quarter percentage point.

Much has changed since the last scheduled FOMC meeting on September 16th. For one thing, an emergency meeting earlier this month produced a Fed-led round of joint central bank interest rates in which the Fed, ECB, Bank of England, Bank of Canada, and Swedish Riksbank each cut rates by 50 basis points and the Swiss National Bank, Peoples Bank of China, and Bank of Korea (on the following day) reduced rates by about 25 basis points. The trade-weighted dollar has risen 11% since September 16th. The DJIA has plunged 23.6%. Ten-year Treasury yields are 40 basis points higher now than then, but oil prices are roughly 30% less expensive. Virtually all commodity prices are at least 10% lower. The banking crisis has escalated, and so have recessionary forces in the United States and on a global scale.  Markets expect the Fed to cut 50 basis points, but some analysts prefer a move of 25 basis points, claiming that the difference between 25 bps and 50 bps is not significant in current circumstances and that the Fed may wish to have more room to cut in the future. I believe that 50 basis points is the better move and not merely as some maintain to put pressure on the ECB to cut rates or to avoiding disappointing investors who look for 50 bps. The trade-weighted appreciation of the dollar since September 16th is akin to an interest rate increase of around 120 basis points. Dysfunctional money markets, the steep fall in share prices, and higher long-term interest rates outweigh any boost from lower energy costs. Without a rate cut of at least 50 basis points, U.S. monetary conditions will on balance be left tighter than such were on September 16th.



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