The Reserve Bank of Australia raised its cash rate 0.25 percent in November to 6.75 percent. The increase is the second in 2005, but just the fifth since the end of 2003.

Sweden’s Riksbank raised its repo rate 0.25 percent in late October to 4 percent. Sweden has increased rates twice in two months and 10 times since the rate stood at 1.5 percent in December 2005.

The Central Bank of the Philippines dropped its overnight borrowing rate 0.25 percent in November for the second straight month, sending the rate down to 5.5 percent.

The Bank of Mexico raised its 28-day Cetes rate 0.1 percent in October to 7.3 percent, the third rate increase in 2007. Mexico had previously been in a loosening cycle, dropping the rate from 9.6 percent in June 2005.

The Central Bank of Turkey decreased its overnight borrowing rate 0.50 percent for the third month in a row in November, lowering the rate to 16.25 percent. The rate was 13.25 percent in April 2006 but gained more than 4 percent in the next few months.

The National Bank of Poland raised its 28-day intervention rate 0.25 percent in November to 5 percent. The rate went untouched for more than a year after dropping to 4 percent in February 2006.

• The Swiss National Bank increased its 3-month Swiss Libor 0.25 percent in September to 2.75 percent. The increase is the 10th 25-basis point rise since the end of 2003, and the third in 2007.
  
  
• The Swedish Risbank raised its repo rate 0.25 percent in September to 3.75 percent. The rate has been raised nine times since January 2006.
  
  
• The Central Bank of Taiwan increased its discount rate 0.125 percent in September to 3.25 percent. The discount rate stood at 1.375 percent in December 2003 but has more than doubled after 12 rate hikes.
  
  
• The Central Bank of Brazil dropped its Selic rate 0.25 percent in September to an all-time low 11.25 percent, continuing a loosening cycle that began two years ago. In August of 2005, the Selic stood at 19.75 percent, but 18 cuts in 25 months have slashed the rate.
  
  
• The Central Bank of Chile raised its discount rate 0.25 percent for the thirdstraight month, boosting the rate to 5.75 percent in September. With the exception of a 0.25 percent cut in January, the discount rate has been increased 15 times since 2004.
  
  
• The Czech National Bank raised its two-week repo rate 0.25 percent in late August to 3.25, remaining in a tightening cycle that included three rate hikes in four months.
  
  
• The Central Bank of Turkey lowered its overnight borrowing rate for the first time since 2006, dropping it 0.25 percent to 17.25 percent in September. The rate had a huge, 4-percent jump in June 2006 that preceded another 0.25-percent move in July.
  
  
• The National Bank of Hungary drastically cut its two-week deposit rate by 0.75 percent in September to 7.0 percent. The rate was hiked from 6 percent to start 2006 to 8 percent by year’s end, but the big September move follows a quarter-point drop in June.

• The Reserve Bank of Australia raised its cash rate 0.25 percent in August to 6.5 percent — a 10 year high. The rate hike was the first since November 2006.
  
  
• The People’s Bank of China raised its one-year yuan lending rate 0.18 percent to 7.02 percent in August.
  
  
• The Bank of Korea raised its overnight call rate 0.25 percent in August to 5 percent, the second increase in as many months. The back-to-back increases come after 11 months of inactivity.
  
  
• The Reserve Bank of New Zealand increased its cash rate in July 0.25 percent to 8.25 percent, continuing its tightening policy. The rate raise was the fourth since March after not raising rates since December 2005.
  
  
• Norway’s Norges Bank raised its deposit rate in August 0.25 percent to 4.75 percent. This is the 12th straight hike since the rate stood at 1.75 in May 2005.
  
  
• The South African Reserve Bank raised its repurchase rate 0.5 percent in August to 10 percent. In an effort to slow down a scorching South African economy, the bank has raised rates 50 basis points six times since June 2006.
  
  
• The Central Bank of Chile increased its discount rate 0.25 percent for the second month in a row in August, bringing the rate to 5.5 percent. Chile began the year by dropping rates to 5 percent in January, but the hikes that began when the discount rate was 2.25 at the end of 2003 have returned.
  
  
• The Bank of Israel increased its shortterm lending rate in August 0.25 percent to 4 percent, continuing a topsy-turvy route with the rate. The raise is the second in as many months, and they follow seven rate cuts in eight months. The cuts were preceded by seven straight rate hikes.
  
  
• The Czech National Bank raised its two-week repo rate in July 0.25 percent to 3 percent. The rate is at a multi-year high.
  
  
• The National Bank of Poland increased its 28-day intervention rate 0.25 percent in August to 4.75 percent. The hike is the third in five months, which followed seven consecutive cuts beginning in March 2005.

• As expected, the European Central Bank raised its refi rate 0.25 percent to 3.75 percent in early March. After keeping rates steady at 2 percent for more than two years from 2003-2005, the ECB has increased the refi rate 25 basis points seven times since December 2005.
  
  
• The Swiss National Bank stayed in step with the ECB by increasing its 3-month Swiss Libor rate 0.25 percent to 2.25 percent on March 15. Since the end of 2005, the Swiss bank has raised rates 25 basis points six times.
  
  
• The Norges Bank, the central bank of Norway, raised the benchmark deposit rate in March 0.25 percent to 4.0 percent, the fourth such move in five months. The bank has increased rates nine times since June 2005.
  
  
• Denmark’s National Bank’s 2 week CD rate was raised 0.25 percent to 4 percent in March. The move was the first in 2007, and it continues a tightening cycle started in December 2005 when the rate stood at 1.75 percent.
  
  
• The Central Bank of Brazil continued to drop the benchmark Selic rate, as another 25 basis-point decline in March sent the Selic to an all-time low of 12.75 percent. The rate stood at 19.75 percent in August 2005 but has since been reduced 14 times.
  
  
• Bank Indonesia dropped its reference rate for the ninth straight month in March, this time 0.25 percent to 9 percent. The reference rate shot up from 7.4 percent in March 2005 to 12.75 percent in January 2006, but has been declining ever since.
  
  
• The rate decline also continues in Israel, where the Bank of Israel dropped its short-term lending rate 0.25 percent to 4 percent in late February. It was the fifth consecutive month of declining rates, although the short-term rate is still slightly higher than where it was at the end of 2004 (3.7 percent).
  
  
• The Reserve Bank of New Zealand ended a lengthy period of inactivity by increasing its cash rate 0.25 percent to 7.5 percent in early March. New Zealand had not changed the cash rate since December 2005, when it increased 25 basis points to 7.25 percent. The rate hike is only the fourth in nearly three years.

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The People’s Bank of China raised its one-year lending rate to 7.47 percent in December. This 0.18 percent raise was the sixth of 2007, where rate increases totaled 1.08 percent overall.

The Central Bank of the Philippines lowered its overnight borrowing rate 0.25 percent to 5.25 percent in January, the fourth 0.25-percent decrease in six months.

The Central Bank of Taiwan raised its discount rate 0.125 percent to 3.375 in January. Taiwan’s rates have steadily increased over the last several years, adding 1.5 percent over the last three years.

The Central Bank of Chile raised its discount rate 0.25 percent in January to 6.25 percent. This is the fifth raise in a year, totaling 1.25 percent since January 2007.

The Bank of Israel raised its short-term lending rate 0.25 percent to 4.25 percent in January. This raise returns the rate to its January 2007 level after it fell to 3.5 percent in the middle of the year.

The Central Bank of Turkey decreased its overnight borrowing rate 0.25 percent in January to 15.5 percent. This is the fifth decrease in a row since Turkey raised rates 4.5 percent to 17.5 percent in July 2006.

The National Bank of Ukraine raised its discount rate 2.0 percent to 10 percent in January, the first rate change in more than a year.

The National Bank of Romania raised its discount rate 0.5 percent in January to 8.0 percent. The raise follows four rate cuts since February 2007 when the rate also stood at 8.0 percent.

• The Central Bank of Brazil lowered its Selic rate in April 0.25 percent to an all-time low of 12.5 percent. The reduction was the 15th since August 2005 when the rate stood at 19.75 percent.
  
  
• The Central Bank of Taiwan raised its discount rate 0.125 percent in March to 2.875 percent. The CBT has not implemented a rate decline in more than four years.
  
  
• The Bank of Thailand dropped its one-day repurchase rate 50 basis points to 4.0 percent in April. The rate drop is the third in 2007, which followed more than four years of rate increases.
  
  
• The Bank of Israel dropped its short-term lending rate 0.25 percent in April to 3.75 percent, continuing its tightening policy. Since October 2006, when the rate stood at 5.5 percent, Israel has dropped its rate every month except one.
  
  
• The National Bank of Poland increased its 28-day intervention rate 0.25 percent in April to 4.25 percent, ending a long period of rate neutrality. The last rate change in Poland was February 2006, when the rate fell 25 basis points to 4.0 percent.

• The People’s Bank of China increased its one-year yuan lending rate 0.17 percent to 7.29 percent in September.
  
  
• The Norges Bank of Norway raised its deposit rate 0.25 percent to 5 percent in late September. The bank has raised rates 25 basis points 12 times since November 2005.
  
  
• The South African Reserve Bank boosted its repurchase rate 0.5 percent in October to 10.5 percent. The increase is the third 50-basis-point increase since June and the seventh since June 2006.
  
  
• The Central Bank of Turkey dropped its overnight borrowing rate 0.5 percent in October to 16.75 percent. The reduction is the second in as many months, and it follows a period of inactivity that stretches back to July 2006.
  
  
• The National Bank of Hungary dropped its two week deposit rate 0.25 percent in September to 7.5 percent, the second decline in four months after a five month tightening period in mid- to late-2006.
  
  
• The Central Bank of the Philippines dropped its overnight borrowing rate 0.25 percent in October to 5.75 percent. The drop comes three months after a huge 1.5-percent reduction, which was the first move in the rate since October 2005.

How will higher short-term interest rates in Japan impact expected inflation? Japan has had an inflation-linked bond market since April 2004. While this history is nowhere near as long as we would like it to be, we can make three intriguing observations by mapping 10- year expected inflation against overnight call money.

First, while the expected inflation rate more than doubled between August 2005 and May 2006, it fell sharply in November 2005 (green arrow) when BOJ Governor Fukui warned of an impending credit tightening. Second, expected inflation peaked in May 2006 (magenta arrow) just before the BOJ raised rates. Third, inflation expectations hit a local bottom in early March 2007 (blue arrow) and then rebounded sharply as the BOJ injected liquidity into the banking system. The BOJ’s current account balance jumped from ¥5.88 trillion on March 7, 2007 to ¥12.51 on April 3, 2007. Those inflation expectations then fell sharply as the global credit crunch developed in July 2007.

It would appear from this limited history that higher short-term interest rates lower inflation expectations unless offset by an increase in the monetary base. This provides the BOJ with a tool for ending its years of low interest rates and quantitative easing. If Japan was an economic as well as geographic island, it could maintain higher levels of expected inflation by keeping excess money in its account while raising nominal interest rates to levels that would maintain the global yen carry trade without repeating the disruptions of May 2006 and March 2007. However, Japan’s large external sector and its exposure to those who have borrowed massive quantities of yen over the years subjects its domestic inflation policies to global cross-currents.

After ending a multi-year zero-interest rate policy in July 2006, Japan raised interest rates again in February, 25 basis points to 0.50 percent.

The Bank of Japan (BOJ), citing economic data that came in stronger than expected, voted 8-1 to raise rates to an almost-nine-year high. Japanese economists had expected a rate raise in 2007, but were unsure when it would happen.

A week before the interest-rate change, Japan announced better-than-expected fourth-quarter GDP growth of 4.8 percent, the highest rate in almost three years. The BOJ determined the economic expansion would continue, with consumer spending and prices improving.

Speaking to parliament two days after the rate hike, BOJ governor Toshihiko Fukui said interest rates would be raised gradually to help prolong stable economic growth. Fukui added that interest rates of 0.5 percent are low, considering the Japanese economy grew at a 2-percent clip in 2006.

The yen reacted to the news by selling off against the U.S. dollar for two days before leveling off on Feb. 23. The Nikkei 225, Japan’s benchmark stock index, reacted favorably to the news, opening at 17,896.60 on Feb. 21 and closing at 18,188.42 — a gain of more than 1.5 percent — on Feb. 23.

Short-term interest-rate differentials can explain the dollar’s movement — especially for the critical euro-dollar relationship (see “The dollar super-cycle,” Currency Trader, March 2006).

Between early December 2006 and late January 2007, the market took back the nearly 50 basis points (bps) in Federal Reserve rate cuts it had priced in to the term structure, even though the Fed on numerous occasions indicated that, from its perspective, the upside risk of inflation was greater than the downside risks to growth. The euro pulled back nearly a nickel as the interest-rate expectations were adjusted.

The pendulum of market expectations swung as far as macroeconomic performance would allow. By the middle of February it became clear the preliminary estimate of U.S. Q4 GDP of 3.5 percent would be subject to a substantial downward revision to reflect new trade, inventory, and construction data. Moreover, on balance, indications point to growth in the 2.0- to 2.5-percent range for Q1 2007. The easing of short-term U.S. rates and the narrowing differential with the Eurozone, where growth appeared more solid in Q4, was accompanied by a down move in the dollar.

In his semiannual testimony before Congress, Federal Reserve Chairman Ben Bernanke appeared more confident current policies would foster sustainable growth and the gradual ebbing of core inflation — the picture- book definition of an economic “soft-landing.” While housing still posed a risk to growth, the greater risk remained that core prices would prove sticky.

Bernanke, who has eschewed the strategic ambiguity of his predecessor, Alan Greenspan, was clear: While there were some indications inflation pressures were beginning to moderate, the data was noisy and “it would be some time before we can be confident that underlying inflation is moderating as anticipated.” The unequivocal message from the Federal Reserve is that inflation is decidedly on hold.

Although not without critics, Bernanke’s first year at the Fed’s helm compares quite favorably with his two immediate predecessors. And even with one of the most inexperienced Federal Reserve Boards in history, its economic forecasts have been uncannily accurate.

The most significant exception was the continued strong performance of the U.S. labor market. The jobs data has been subject to substantial revisions that often make the initial reports quite unreliable. The government initially estimated that 3.3 million jobs were created between March 2005 and December 2006 but, upon review, the government found another million jobs. The strength of the labor market is the key to consumer spending, which accounts for nearly 70 percent of the economy. Despite weakness in home prices and a startling 19.2-percent collapse in residential construction, real consumer spending in Q4 grew at a 4.4-percent annual rate, the second-strongest quarterly performance in three years.

Moreover, in the recent past, the real fed funds rate (currently around 3 percent) has needed to be higher than prevailing levels to sustain non-inflationary growth. In 1994- 1995, the real rate was closer to 4 percent, and in the 1999- 2000 period, it reached 5 percent. If monetary policy acts with a six- to nine-month lag, the effect of the Fed’s tightening through mid-2006 should be diminishing just as the drag from the housing market, autos, and inventory adjustments are starting to decline.

Assuming the economy returns to the path of trend growth as the Federal Reserve forecasts, the tightening cycle might resume in late Q3 or early Q4.

Overall, a number of positive factors have affected the Aussie dollar in recent months. Bullish interest-rate differentials, strong gains in base metal prices, and strong Chinese import demand for raw materials have supported the currency. “The Aussie dollar has all pistons firing with support coming from interest-rate differentials, elevated commodity prices, general U.S. dollar weakness, the carry trade, and strong merger and acquisition flows,” says Prakriti Sofat, economist at Ideaglobal in Singapore.

Rhonda Staskow, regional director of FX Americas and Thomson Financial IFR Markets, notes commodity prices have moved sharply higher amid demand from China and
India, which is supportive to the Australian dollar. Australia is a large base metals exporter and recent gains in tin, copper, and aluminum have helped push the currency to its historic highs. As of April 27, the London Metals Exchange (LME) metals price index was up 17.2 percent year-overyear, and up 8.7 percent on a monthover- month basis, according to data from Credit Suisse.

Staskow has also been keeping an eye on another indicator that may be useful for currency traders: the Baltic Dry Index, an index issued by the London-based Baltic Exchange that is closely watched by many financial market players as a reflection of commodity demand and global demand for shipping. In late April, the index had surged to its highest level since 2004. “Many people say as long as that index is still strong, global demand will stay strong, which will support commodity-based currencies,” Staskow says. For now, the latest readings remain supportive.

The Bank of England increased its bank rate in May 0.25 percent to 5.5 percent. The increase was the first since January, and minutes of the monetary policy committee (MPC) meeting show the MPC nearly raised rates 50 basis points. The move is the fourth 0.25-percent increase since November 2006.

The People’s Bank of China increased its one-year yuan lending rate 0.18 percent to 6.57 percent in late May (see “China loosens yuan restrictions.”) The Bank of Indonesia lowered its reference rate 25 basis points in May to 8.75 percent. The decrease is the 10th in 11 months and the 11th overall since the reference rate stood at 12.75 percent in January 2006.

The Bank of Thailand dropped its one-day repurchase rate in May 0.5 percent to 3.5 percent, continuing its tightening cycle. The decrease is the fourth in 2007, although rates are still well above the 1.25 percent level of December 2003. The Bank of Mexico increased its 28-day Cetes rate 0.1 percent in May to 7.1 percent. The rate has remained between 7 and 7.1 percent since June 2006, when a series of declines brought the rate down from 9.7 percent in May 2005.

The National Bank of Slovakia lowered its two-week limit repo rate in late April 0.25 percent to 4.25 percent. The move was the second 25- basis-point drop in as many months, and it follows four rate increases in 2006.

The Reserve Bank of New Zealand increased its cash rate in late April 0.25 percent to 7.75 percent. New Zealand had not adjusted interest rates since raising them to 7.25 percent in December 2005, but the April increase marked the second consecutive month of a tightening bias.