The European Central Bank (ECB) and the Bank of England (BOE) talked tough as recently as a few weeks ago. In light of recent developments in the credit and money markets, both central banks held their policy rates unchanged today. The ECB left the refi rate unchanged at 4.00%. Trichet, the President of the ECB, indicated that upside risks of inflation remain in place and monetary policy is still accommodative. But, “financial-market volatility and reappraisal of risks over recent weeks have led to an increase in uncertainty.'' Trichet also added that “given this high level of uncertainty it's appropriate to gather additional information before drawing conclusions'' on interest rates. Trichet stressed that the actions the ECB is taking addresses only liquidity and credit problems and not macroeconomic issues. But, it remains mindful of the impact it may have on the macroeconomy. Trichet customarily uses the phrase “strong vigilance” to signal an impending rate hike. The absence of this term in the today’s press release suggests that a rate hike is off the table temporarily. During the press conference Trichet indicated that this phrase will be used when necessary in the future. The ECB also pre-announced a supplementary refinancing operation without any predetermined size at a variable rate. The ECB is using all the tools at its disposal to correct the credit crunch without lowering the main monetary policy rate. The ECB injected $57.7 billion and the Fed added $31.25 billion to boost liquidity today.
The Bank of England (BOE) held the policy rate steady at 5.75%. The BOE noted that it was too early to tell how the broader economy will be affected and that it was closely monitoring developments. Yesterday, the BOE announced that it would inject more reserves and make funds available without the additional 100 basis points penalty. This was the central bank’s response to the sharp increase in the money market rates in recent days.
Both central banks gave no hints about future rate decisions. The major central banks of the world are targeting the liquidity problem in isolation; both Bernanke and Trichet have stressed that the liquidity problem is different from macroeconomic issues. It is not clear how they view the macroeconomy as distinctly separate from the liquidity and credit problems. The Fed’s stance seems to imply that solving the liquidity and credit problems can cure the soft economic conditions without lowering the federal funds rate. It will be three weeks on September 7 since the Fed cut the discount rate and atypical spreads in the credit and money markets are yet to return to pre-crisis levels.
On the other side of the world, the People’s Bank of China remains concerned about an overheated economy which brought about an increase in the reserve requirement to 12.5% from 12.0%. The Chinese central bank has raised the amount lenders have to keep at the central bank every month in 2007, with the exception of holding it steady in March (see chart 2).
Continuing Claims Maintain Upward Trend
Initial jobless claims fell 19,000 to 318,000 during the week ended September 1. The four-week moving average is 325,750, up from 306,000 in the last week of July. Continuing claims, which lag initial claims by one week, rose 25,000 to 2.598 million, the highest since December 2005, excluding similar readings in February 2007. The insured unemployment rate rose to 2.0% from a revised 1.9% reading in the prior week. A meaningful impact of the current credit market crisis on the labor market should be available by early October.
