Intelligentguess

Situation

On a monthly basis prices rose by 0.48 % (0.48% in Feb’07)

On an annual basis prices rose by  3.07 p.a ( 2.78% p.a in Feb’07)

Background

• Bank of England ( BOE) has an inflation target ( CPI ) of 2% p.a.
• BOE’s current policy rate is at 5.25% p.a .The Bank Rate was raised by 0.25% to 5.25% in Jan’07
• Producer prices have had a sharp rise in Mar’07 
• Crude prices which were averaging 59.38$  in Feb’07 had risen to a 60.73 $ average in Mar’07 ( 2.26% rise)
• As on Apr 22 ‘07 crude is averaging at 63.39$. ( 4.39% more than Mar’07) 

Conclusion

In relationship to the monetary policy meeting on May 10th 2007

1. The behavior of the Pound viz other currencies suggests that the market is expecting a rate hike

On the other hand

1. Production has declined in Q1 2007  (data upto Feb’07).
2. GDP growth remained flat in Q4 2006 ( and in relationship to production declines , is not expected to rise in Q1 2007)
3. A raise of interest rates will bring down demand / inflation pressures ( but at the same time drive growth even lower from Q2 2007 onwards) . 

Tis’ a fine balancing act for the BOE 

Related Links

• UK - Producer prices ( PPI) have a sharp rise in Mar’07
• UK - CPI, Inflation marginally up in February’07 (on an annual basis)
• UK - Bank Rate since 1970

• Euro area - Inflation (CPI) flat in Mar’07
• India : Consumer Price Index (CPI) - Prices jump in Feb’07
• Japan - Consumer Price Index (CPI) continues its drops into negative territory in Feb’07
• USA - Inflation (CPI) inches up in Mar’07 , while core inflation drops

• Euro area - Producer Prices ( PPI) : Prices rise at the lowest pace since Aug’04 ( on an annual basis)
• Indian WPI inflation remains high - Expect hawkish monetary policy to continue
• Japan - Producer prices ( PPI ) inches up in Mar’07
• USA - Producer prices continue to grow in Mar’07

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India’s central bank, RBI, releases its annual monetary policy statement Tuesday, April 24 at 0630 hrs UTC.

Analysts widely expect Y V Reddy (YVR), the RBI Governor to continue his hawkish tone in the language of the statement.

There are differences, however, amongst them on whether the central bak would actually go ahead with a rate hike and/or increase in the statutory pre emption of funds (hike in the cash reserve ratio).

The measures announced on March 30 are yet to take effect in full. The second phase of the increased CRR kicks in only this weekend. This, seems to be the main reason why analysts do not expect an immediate announcement of a rate hike.

Personally, I think that a further increase in the cash reserve ratio may be deferred, YVR is unlikely to stay put on the benchmark rate. A 0.25% hike in the official “repo” rate (the rate at which RBi lends to banks) seems more likely. This would take the repo rate to 8%. The reverse repo rate (the rate at which RBi borrows from banks) is at 6%.

A 25 bps hike in the repo rate would take the spread between the official repo and reverse repo rates to 2%. If we remember, the spread between these rates at the time they were fixed initially had been 2%. Successive reductions had brought the spread down to 1%. YVR has, consciously, since October 2006 steadily increased the spread in successive monetary policy announcements. It appears that the game plan is to take this spread back to the originally conceived 2%.

Further hikes in benchmark rates in future might involve an increase in both the “repo” rate as well as the “reverse repo” rate.

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