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The King has left The King has left
by Tony Butcher
Issue 12
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The King has left the building. Now the United States of America and a small percentage of the rest of the world is in the hands of Ben Bernanke. He will have to preside over further rate increases and his first few speeches will be scrutinised very closely to get some indication where he plans to halt the current cycle.

In a private speech Alan Greenspan has suggested the markets have underestimated how far the Federal Reserve plans to go, however this may be his continuing attempt to increase the yield on long dated bonds.

In America, mortgage interest repayments are based on long dated bonds, which is 30 year debt issued by the government. Unlike the United Kingdom (4.5%) and Europe (2.25%) whose rates are set against short-term central bank base rates. At the moment, in the US, the yield curve has inverted this is where the yield on the 2-year debt (4.64%) is greater than the yield on the 30-year debt (4.5%). This has been a precursor for an economic recession in modern times and if the curve inverts even more than it has, it is currently about 0.1% difference (10/02) this will become a serious issue for the Federal Reserve.

We are only a few weeks away from the next European Central Bank (ECB) rate rise. In March Jean Claude Trichet will crank up rates to 2.5% in his continued vigilance against inflationary pressures. In his February press conference he said he was pleased that the markets had understood his comment that the ECB were not beginning a series of monthly rate rises, so that is a gold star for all of us then. It looks however that quarterly rises are on the agenda as the ECB will look to have the European base rate at around 3% by the end of 2006.

I have to point out these rises are not because the European economies are outperforming at the moment, because they are not. Recent GDP (Gross Domestic Product) figures from France and Germany still show annual growth at less than 1.5% compared to the UK 1.8% and the United States 3.3%, which has had the devastating effects of Hurricane Katrina to deal with.

The ECB moves are purely a response to increasing risks to price stability in the form of inflation. Excess liquidity in the money markets and rising oil prices have been highlighted as primary reasons for the current round of fiscal tightening. As interest rates increase so does the savings ratio, whereby people will save more money and spend less, which removes money from the economy and reduces the excess liquidity. It should also be pointed out that if the ECB do not raise rates now, if there was a serious global economic downturn, either as a result of bird flu or another cause, then the ECB has no room for manoeuvre; given real interest rates are very close to 0%.

I could not leave this month without mentioning the amazing strength which continues to be shown in the stock markets across the world. The FTSE 100 in the United Kingdom has reached 4 and half year highs above 5800. Will the short month of February and onset of spring see these markets stronger and stronger into 2006, at the moment I would not like to be standing in the way of this train.


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