Inflation Drives Exit-from-Stimulus Strategies

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The US FOMC continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period and will maintain the target range for the federal funds rate at 0 to 1/4 percent. However, in light of improved functioning of financial markets, the Fed has been closing the special liquidity facilities that it created to support markets during the crisis. The only remaining such program, the Term Asset-Backed Securities Loan Facility, is scheduled to close on June 30 for loans backed by new-issue commercial mortgage-backed securities and on March 31 for loans backed by all other types of collateral. To provide support to mortgage lending and housing markets the Fed has been purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt; those purchases are likely to be executed by the end of this month.

ECB decided to leave the key interest rates unchanged as Euro zone inflation in February is at 0.9% and monetary analysis confirms the assessment of low inflationary pressures over the medium term, with money and credit growth remaining weak. But ECB announced the gradual phasing-out of our non-standard operational measures which includes return to variable rate tender procedures in the regular three-month longer-term refinancing operations (LTROs), starting with the operation to be allotted on 28 April 2010, further allotment amounts in these operations will be set with the aim of ensuring smooth conditions in money markets and avoiding any significant spreads between bid rates and the prevailing MRO (main refinancing operations) rate.

Policy makers in UK on the other hand had to acknowledge emerging evidence on the upside risks to inflation, though at the moment Bank Rate would be maintained at 0.5% despite the fact that UK inflation has increased to 3.5%, above the government's target. BoE would also maintain the stock of asset purchases financed by the issuance of central bank reserves at £200 billion as lending growth to households and businesses had remained weak, reflecting both demand and supply factors and was likely to remain constrained until the banking sector had completed the process of balance sheet restructuring and the refinancing of its own funding maturing over the coming years.

RBI of course decided to act prior to its annual policy review and has increased its key rates by 25 bps citing that containing overall inflation and anchoring inflation expectations have become imperative as inflationary pressures have intensified beyond RBI’s baseline projection and heighten the risks of supply-side pressures translating into a generalised inflationary process. After revision, the reverse repo rate — the rate of interest that the RBI offers banks when they leave their funds with the central bank — is 3.50%, nearly 42% lower than the pre-crisis level of 6%. The repo rate, at which banks can borrow from the central bank, is now 5%, 44% lower than the pre-crisis peak of 9% leaving enough scope for further hawkish measures probably again before its annual review, as headline WPI inflation which on a year-on-year basis stands at 9.9 per cent in February is expected to reach double digits in March 2010.