Central Banks: Who Will Raise Rates, Cut Rates or Leave them Unchanged?

Interest rates have a huge impact on forex trading, and currently, central banks have been on edge as volatility in the financial markets may have derailed plans for further monetary policy tightening. Over the course of the next week, a total of four central banks will meet and announce their rate decisions, and the Australian dollar, Canadian dollar, Euro, and British pound could all be subject to a jump in volatility as the RBA, BOC, ECB and BOE all continue to hold a hawkish bias. However, only one bank shows a substantial risk of an imminent hike this week. Who will it be? Also, what will the Federal Reserve?s next move be?

The chart below highlights which central banks we consider to have the most severe tightening bias and more importantly, which are the most likely to increase interest rates in the near term. While all of them have demonstrated a hawkish stance lately, certain factors pertinent to their respective economies leave banks, such as the European Central Bank, prone to earlier action.
Central Bank
Current Target Interest Rate
Next Policy Meeting
Likely Action
Federal Reserve
Possible Rate Cut
Reserve Bank ofNew Zealand
No Change
Bank of Canada
No Change
Reserve Bank of Australia
No Change
Bank of England
No Change
Bank of Japan
No Change
Swiss National Bank
1.75% - 2.75%
No Change
European Central Bank
No Change, but Chance of Rate Hike

Federal Reserve: The Rate Decision That Will Be Heard Around the World
Rate Announcement: September 18, 2007 at 18:15 GMT
Bias: Possible Rate Cut

The US markets have made it very clear that they are begging for a rate cut on September 18th, and the stakes are quite high for the Federal Reserve, as a continued liquidity crunch threatens to severely impair financial operations and economic growth. The Federal Reserve has taken many measures to try to stem some of these pressures, as they lent billions of dollars of temporary reserves to the banking system and also went so far as to cut its discount rate by 50 basis points to 5.75 percent on August 17th in an attempt to help distressed banks borrow money.
Nevertheless, Ben “Helicopter” Bernanke could be coming in with additional assistance for the markets, and he will have the opportunity to discuss his next move with the rest of the FOMC and central bankers from the Bank of England and the Bank of Japan (European Central Bank President Jean-Claude Trichet cancelled his appearance this morning) on August 31st at the Federal Reserve?s annual symposium in Jackson Hole, Wyoming. Currently, Fed fund futures are pricing in a 25 basis point rate cut on September 18th and as many as three rate cuts are expected by year end. However, any commentary by Bernanke that sways investor sentiment on coming monetary policy will shift market expectations and spark major price action. Traders should also keep in mind that Bernanke and other policymakers attending the conference could also be quoted over the course of the weekend events, which may be reflected in the markets on Monday.
Next Week Is Full of Central Bank Decisions - Who Is at Risk of Raising Rates, and Who Isn?t?
Reserve Bank of Australia - No Hike This Month, But Tightening Bias Remains
Rate Announcement: September 4, 2007 at 23:30 GMT
Bias: No Change

On August 8th, the RBA raised rates 25bp for the first time since last November, lifting the overnight cash rate to an 11-year high of 6.50 percent. The move was widely expected after inflation figures for the second quarter came in stronger-than-estimated at 2.1 percent. The bank?s bias going forward was considered to be hawkish as well after RBA Gov. Glenn Stevens said in his policy statement that “the high CPI outcome for the June quarter indicated a less favorable near-term outlook, with the implication that any further increases in inflation would take place from a higher starting point than previously envisaged.”
Furthermore, with unemployment rates holding at 33-year lows of 4.3 percent and domestic data signaling resilient growth in demand and activity, the RBA may remain concerned that strong economic conditions will put upward pressure on inflation. However, in order to preserve stability, the bank will likely want to gauge the impact of past policy actions before considering hiking again. The next round of CPI data not due out until late-October, but interest rate swaps are currently pricing in a 25 basis point hike before year end, creating the potential for an increase in November.

Bank of Canada - Neutral Stance Until 2008
Rate Announcement: September 5, 2007 at 13:00 GMT
Bias: No Change

The Bank of Canada sprung no surprises on July 10th when they raised rates by 25 basis points to 4.50 percent, but the central bank was widely perceived to have maintained as a hawkish bias when they said in their post-meeting policy statement that “some modest further increase in the overnight rate may be required to bring inflation back to the target over the medium term,” citing “excess demand” in the economy that could lead inflation to peak at 3 percent this year. However, recent volatility in the financial markets, which has taken a particularly harsh toll on Canadian commercial paper markets, has also deferred rate hike expectations until 2008 from previous estimates of a September rate increase. Indeed, Bank of Canada Deputy Governor Pierre Duguay recently said,“given recent events in global credit markets, we need to assess the extent to which the risks around our July projections have shifted.”
Furthermore, economic data doesn?t signal an urgent need for monetary policy tightening, as retail sales for the month of June recently plummeted a greater-than-estimated 0.9 percent. Also, the Bank of Canada?s core CPI measure eased closer to their 2.0 percent inflation target to 2.3 percent, down from 2.5 percent the month prior. On the other hand, the unemployment rate fell to a fresh 33-year low of 6.0 percent in July, creating the potential for increased consumption and tighter capacity. Given these upside inflation risks, the Bank of Canada is anticipated to raise interest rates once again in early 2008.

European Central Bank - 25bp Hike Priced In, But Will Trichet Delay It Until October?
Rate Announcement: September 6, 2007 at 11:45 GMT
Bias: No Change, But Chance of Rate Hike

Though European Central Bank President Jean Claude Trichet and his fellow policy makers were supposed to be on their summer break, the group surprised the market on August 2nd by calling an impromptu press briefing after their monetary policy meeting in Frankfurt. As expected, the bank left rates steady, and the policy brief made sure to repeat the upbeat forecast for growth and projected “upside risks to price stability over the medium term.” Nevertheless, it was the reinsertion of the phrase “strong vigilance” that garnered all of the attention. Since the European Central Bank began raising interest rates, these two words have preceded a rate hike with 100 percent accuracy.
Over the past two weeks, however, Trichet has started to backpedal as volatility in the financial markets has weakened the case for an aggressive policy tightening stance. On August 28th, Trichet commented, “What I said on the second of August was before the market turbulence?the next assessment is to be made on September 6. We will then have to assess all of the elements of?the economy. We will assess the risks?and will take the appropriate steps at that moment.” Though a rate hike by the European Central Bank is certainly not off of the table, Trichet has made it clear that his decision has not been made quite yet, and the status of the financial markets up until the meeting will likely play a large role in whether or not he goes through with a 25 basis point hike to 4.25 percent.

Bank of England - Has the Tightening Cycle Come to an End?
Rate Announcement: September 6, 2007 at 11:00 GMT
Bias: No Change

As expected, the Bank of England?s Monetary Policy Committee announced on August 2nd that it was leaving the nation?s overnight lending rate unchanged at 5.75 percent. The pass came as little surprise to both economists and market participants as the central bank had lifted the overnight cash rate by 25 basis points at its previous gathering on July 5th. Nevertheless, the bank was perceived as remaining unabashedly hawkish, especially following the publication of the Bank of England?s quarterly inflation report, where it warned that inflation risks were “slightly on the upside” and forecasted that without an increase in rates to 6 percent, inflation was likely to continue overshooting its 2 percent target.
This perception of a tightening stance remained until inflation figures for the month of July were released. Headline CPI surprisingly plummeted below the Bank of England?s inflation target to a reading of 1.9 percent from 2.4 percent, effectively negating one of the central bank?s main reasons for tightening monetary policy further. Moreover the MPC minutes reflected a 9-0 for no change in rates at its August meeting, and also showed that most members emphasized they had no firm view on whether rates would need to rise further. As a result, the Bank of England is likely to follow the market?s lead, which is currently pricing no change in interest rates before year-end.
In Case You Are Wondering: What Are The Rest Of The Central Banks Doing?
Reserve Bank of New Zealand - On Hold Until Further Notice
Rate Announcement: September 12, 2007 at 21:00 GMT
Bias: No Change

On July 26th, Reserve Bank of New Zealand Governor Alan Bollard announced the bank’s fourth consecutive 25 basis point interest rate hike, which brought the overnight cash rate to a staggering 8.25 percent - the second highest amongst Aaa-rated countries (Iceland?s rates are the highest) and a new nine-year high in its own right. In the bank’s subsequent policy statement, Bollard said, “New Zealanders have been showing early signs of moderating their borrowing,” and provided that this trend continues “the four successive rate increases delivered will be sufficient,” signaling that the tightening cycle may be over.
Though the market and economists were aligned in their expectations of the policy decision, the central bank?s stubbornly hawkish streak has received substantial opposition, as the surge in interest rates helped push the New Zealand dollar to multi-decade and record highs against its major counterparts, incurring much damage to the country’s exporters. Supporting the notion that interest rates have grown excessive are a number of consumer, business and inflation reports. Local firms have arguably suffered the most with the high rates through costs incurred through loans and demand, with sentiment surveys like the quarterly NZIER Business Opinion gauge and the monthly ANZ Business PMI reporting a pessimistic turn en masse. As a result, markets are pricing in steady rates throughout the rest of the year, as expansion could suffer quite heavily with the economy operating in such tight monetary conditions.
Swiss National Bank - Rate Normalization Schedule Intact
Rate Announcement: September 13, 2007 at 12:00 GMT
Bias: No Change

As expected, the Swiss National Bank voted to raise the target range for the three-month Libor rate 25 basis points to 2.00 - 3.00 percent at the conclusion of its June 14th meeting. The commonly quoted 2.50 percent average marks a six-year high and the seventh increase in the past two years for the benchmark lending rate. While inflation was well below the central bank?s self-imposed 2.0 percent limit, the heady pace of economic expansion over the past few quarters kept the threat of a rebound in price growth at hand.
While headline inflation has remained remarkably tepid at an annualized rate of 0.8 percent, but the import and producer price index recently hit 11 month highs, and these undercurrents have not escaped the vigilant eye of policy officials. In the statement following the announcement of June?s hike, President Roth intensified his hawkish language, leading the investment community to price in further hikes down the line. Furthermore, recent volatility in the financial markets is unlikely to dissuade Roth from normalizing rates, as he said on August 20th, “We hope that volatility stays higher. What we had was not normal, namely, practically no volatility?Markets cannot be a one-way street, or you will get excess.” With a 25 basis point rate increase priced in for the September meeting, traders will likely be proved correct as the Swiss National Bank keeps their rate normalization schedule intact.

Bank of Japan - 25bp Priced In Despite Clear Government Opposition
Rate Announcement: September 19, 2007 at approximately 4:00 GMT
Bias: No Change

For the past six months, the Bank of Japan has kept interest rates unchanged at 0.50 percent - by far the lowest overnight lending rates amongst the industrialized countries. The Bank’s neutral stance has not been entirely surprising as CPI has consistently indicated that the Japanese economy is still in deflation, as Tokyo core CPI (excluding fresh food and energy) recently fell -0.3 percent on an annual basis, marking the sixth consecutive month of contracting prices. Nevertheless, Fukui is widely perceived as remaining determined to secure his legacy of “normalizing” monetary policy after successfully putting an end to zero-interest rate policy (ZIRP) in 2006, despite major resistance from political and fiscal officials. In fact, LDP Secretary General Hidenao Nakagawa - who is under pressure to resign - directly blamed previous BOJ rate hikes for the LDP losses in July?s upper house election, saying that the bank left the government unable to achieve its growth target.
With consumption growth still very tepid, traders only see a 13 percent chance of a rate hike at the bank?s September meeting. However, the interest rate curve is pricing in one rate hike by the end of the year, and it appears that a return to positive price growth is all that is needed for Fukui to feel vindicated in continuing rate normalization this year.

Written by Terri Belkas, Currency Analyst for DailyFX.com