News of the week summary - 08/04/2024
Bank of Japan raises rates and slashes bond purchases
The Bank of Japan (BOJ) has made a significant shift in its monetary policy by raising its benchmark interest rate to 0.25% from the previous range of 0-0.1%. This marks the highest rate since the global financial crisis of 2008. Additionally, the BOJ announced plans to cut its monthly bond purchases from ¥6 trillion (approximately $39 billion) to around ¥3 trillion by spring 2026.
This move is designed to address the persistent weakness of the Japanese yen, which has been driven in part by differing monetary policies between the BOJ and the US Federal Reserve. With the Fed likely to maintain or increase its own interest rates, the BOJ's decision to tighten its policy is expected to narrow the interest rate gap between the two economies. As a result, the yen strengthened by over 1.7% to ¥150.15 against the dollar following the announcement.
The BoJ's decision follows a period of unusually direct criticism from Japanese government officials, who have pressured the central bank to address the yen's depreciation. Governor Kazuo Ueda explained that the rate hike was prompted by ongoing economic conditions and inflation trends. Core inflation in Japan, which excludes volatile food prices, has been above the BoJ's 2% target for 27 consecutive months, reaching 2.6% in June. However, despite this, Japan's economy contracted in the first quarter of the year, partly due to the yen's decline and rising living costs affecting household spending.
Looking ahead, Ueda indicated that the BOJ plans to continue raising the policy rate and adjusting its monetary stance if economic conditions and inflation align with forecasts. The reduction in bond purchases and the rate hike represent a significant shift away from the BOJ's previous ultra-loose monetary policy, which had been in place for years to combat deflation and stimulate growth.
Bank of England cuts interest rates for first time in 4 years
The Bank of England (BOE) has reduced its key interest rate to 5% for the first time in more than four years, signaling a shift in its monetary policy. This move is seen as a boost for the new Labour government’s efforts to stimulate economic growth.
The decision, which came after a closely contested vote of 5-4 by the BOE’s Monetary Policy Committee, follows a period of easing inflation. Inflation had returned to the BOE’s target of 2% in May and remained there in June, though services inflation has remained persistently high. BOE Governor Andrew Bailey, who supported the rate cut, emphasized that while easing inflationary pressures allowed for this reduction, the bank needs to remain cautious.
Market reactions included a decrease in two-year bond yields, which fell to 3.69%, their lowest in over a year. The British pound also fell to a four-week low of $1.2772 against the dollar, down 0.6% on the day.
For Chancellor (UK equivalent to minister of finances) Rachel Reeves, the rate cut is a welcome development as she seeks to revive the economy and address a £22 billion shortfall in public finances. Despite the positive move, Reeves highlighted that many families are still dealing with higher mortgage rates due to previous economic policies. She emphasized the need for continued tough decisions to stabilize and grow the economy.
This rate adjustment aligns with a broader trend among central banks, reflecting growing confidence that the sharp post-Covid-19 inflation has been controlled. The European Central Bank recently lowered rates, and the Federal Reserve is also expected to follow suit with a potential cut by September.
The BOE anticipates that inflation will rise slightly to 2.7% later this year before slowing down. It has also upgraded its GDP growth forecast for 2024 to 1.25% from a previous estimate of 0.5%, and expects growth to continue at 1% in 2025.
Global stocks plunge after weak US employment report
A sharp global stock market sell-off was triggered yesterday by a significant slowdown in US hiring, driving major indices into a downturn. The Nasdaq Index, heavily weighted with technology stocks, fell 2.4%, entering correction territory as its losses since its July 11 peak exceeded 10%. This decline was fueled by disappointing tech earnings and a jobs report that showed the U.S. economy added only 114 000 jobs in July, falling short of the anticipated 175 000.
The S&P 500 also dropped 2%, extending its previous day’s losses. US bond yields fell sharply as investors sought the safety of government securities, betting that the Federal Reserve would need to respond to the weakening economy with aggressive rate cuts. The yield on the 10-year Treasury note decreased by 0.15 percentage points to 3.82%, its lowest level since December. Investors now expect the Fed to reduce rates by more than a full percentage point by the end of the year.
The market turmoil extended to Japan, where the Topix index, which had recently hit a record high, plummeted 6%—its largest single-day drop since 2016. This sell-off was exacerbated by the Bank of Japan’s unexpected interest rate hike, which caused the yen to appreciate more than anticipated. Concerns about corporate profits in the wake of this policy change contributed to the market decline.
In Europe, the Stoxx Europe 600 index fell 2.7%, reflecting broader global concerns about economic slowdowns. Smaller U.S. stocks also experienced a downturn, with the Russell 2000 index falling more than 3% for the second consecutive day, marking its worst one-week decline in over a year.
In Japan, the sell-off was further aggravated by retail investors, who rushed to sell off holdings in a popular exchange-traded fund, the Nomura NF Nikkei 225 ETF. This ETF closed down 11.46% as individual investors scrambled to mitigate losses. Brokers reported that this frenzy of profit-taking was compounded by larger funds reducing their risk exposure, hitting Japan’s markets particularly hard.
Ethiopia floats its currency
Ethiopia has initiated a significant economic reform by floating its currency, the birr, meaning the exchange rate will not be fixed by the central bank, but will depend on supply and demand on currency markets. This is a part of an effort to address severe foreign currency shortages and attract foreign investment, and secure over $10 billion in funding from the International Monetary Fund (IMF) and the World Bank, as well as to restructure its debt after defaulting in December.
The Ethiopian central bank announced the shift to a market-based exchange rate system, replacing the previous managed float that had created a critical shortage of dollars needed for imports and for foreign investors to repatriate profits. The currency devaluation was immediate, with the Commercial Bank of Ethiopia quoting the birr at around 75 to the US dollar, a significant drop from the previous official rate of about 57 birr.
This reform is expected to correct long-standing economic distortions. However, it also raises concerns about inflation, which is already high at 20%. Indeed, the weaker currency could further drive up the cost of imported goods, potentially leading to even higher inflation.
The decision to float the birr comes after years of pressure from lenders and investors, who argued that the previous system had led to an unregulated parallel market and high inflation. The Ethiopian government, led by Abiy Ahmed, began implementing pro-market reforms in 2018 to open up an economy that had been largely state-controlled for decades.