Central banks are very powerful determinants of interest rates and exchange rates. It has therefore been very disconcerting to financial market participants that the norm since December 2003 has been for central banks to spring surprises.
The first major central bank to surprise the markets was the South African Reserve Bank (SARB), when it decided on December 11 2003 to cut rates by 50 basis points instead of the expected 100 or 150 basis points. There was not even a single economist that had predicted a 50 basis points cut.
Hours later, the central bank of Chile surprised the markets by cutting by 50 basis points after keeping rates steady since January 2003.
The Chileans followed the December surprise with a January surprise when they cut by a further 50 basis points with the benchmark rate now at a record low of 1,75%.
The Brazilians followed the lead of the South Africans when they did not cut in January after cutting every month since June 2003, while the Canadians followed the lead of the Chileans, when they cut in January.
Although they did not change rates, the Americans, in charge of the world’s largest financial markets, caused consternation by their choice of words when they replaced “considerable” by “patience” resulting in a global sell-off in equities and bonds.
South African financial market participants are therefore understandably skittish and have priced in a 180 basis points hike for February 2005.
Many economists think this is too aggressive an interest-rate scenario, with the median forecast being no change in interest rates during 2004.
SARB Governor Tito Mboweni now has the unenviable task for a central-bank governor of saying things are in fact better than priced in by the financial markets, without actually cutting interest rates.
Although unscheduled monetary policy committee (MPC) meetings are only used rarely, because they are unscheduled they have a very powerful signalling factor.
The United States used an unscheduled rate cut in January 2001 to signal its very aggressive monetary stimulus, while in South Africa there have been unscheduled meetings in October 2000, January 2002 and September 2003.
The perceived need to bring interest rates down before the US starts raising interest rates has been behind the rapid decline in interest rates in 2003, which has, however, lagged the pace of Brazilian interest rate cuts, where the policy making body meets monthly.
The SARB has cut by 550 basis points in five cuts spread over seven months (June to December) in 2003, after increasing interest rates by 400 basis points over nine months (January to September) in 2002.
The Brazilian central bank also started cutting in June 2003 after raising interest rates in 2002. It has cut the benchmark Selic rate by 1 000 basis points from the June rate of 26,5%.
November’s 150 basis points Brazilian cut was larger than the expected 100 basis points cut and may have been prompted by the Bank of England’s increase in interest rates at the beginning of November.
This was the first increase in interest rates by any of the four largest central banks since 2000.
This week the Bank of England and European Central Bank policy-making bodies meet and the financial markets should not be surprised if there is a surprise outcome.
The next scheduled SARB MPC meeting is on February 26 and 27. — I-Net Bridge