Inflation Report – March 2008 · 2011. 7. 25. · 64 | Inflation Report | March 2008 annualized...

March 2008 | Inflation Report | 63

4International economyThe international economic scenario was characterized, in recent months, by a revision of the activity level and infl ation forecasts of the world economy. The forecast for the global economic growth rate was revised downwards in response to the sentiment that the United States economy is on its way to a recession period, while infl ation expectations have mostly grown in line with persistent increases in international prices of petroleum and commodities.

In the United States, despite efforts of the Federal Reserve System (Fed) have reached their immediate target of easing the tensions in the interbank market, fi nancial institutions remained strict on granting new credits to consumers and companies, increasing the risks of cooling off the economic activity in the country.

In addition to the downturn, of the U.S. economy, the downward revision of forecasts for world growth refl ects a possible dissemination to the activity level of other countries and economic areas through a slowdown in the pace of growth in international trade. It also takes into account the effects that the American credit market crisis has on the activity level – though milder than those observed in its country of origin – in other world regions, especially in the Euro Area.

4.1 Economic Activity

In the last quarter of 2007, the GDP of the most developed economies continued expanding, while demonstrating strong slowdown in the United States and moderation in the Euro Area. According to preliminary estimates, the United States´ GDP registered annualized increment of 0.6% in the fourth quarter, signifi cantly lower than the 4.9% rate registered in the previous quarter. In the Euro area, on the same comparison basis, the downward pace was less intense, registering a drop of 1.4 p.p., to 3.1% on the rate of the

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Figure 4.1 – USA, Euro Area and Japan – GDP1/%

64 | Inflation Report | March 2008

annualized output increment. The annualized output growth rate in Japan showed acceleration in the period, surpassing 1.3% in the third quarter, to 3.7%.

The United States´ GDP performance in the fourth quarter refl ected, on the one hand, the contraction of 25.2% in residential real estate investments, against 20.5% in the third quarter, following the decrease in stock levels, which determined a drop of 2.74 p.p. over the annualized growth rate of the period. On the other hand, the consumer expenditures, the most representative component of GDP, registered annualized growth of 1.9% against 2.8% in the previous quarter, contributing 1.32 p.p. to the output growth, while the dollar depreciation, the slowdown in domestic demand and continued economic growth in the rest of the world, favored an increase of the contribution of foreign trade to the GDP, that reached 0.9 p.p. in the quarter.

In response to the risks associated to the real estate market crisis, the United States government adopted a set of fi scal measures to inject US$168 billion in the country’s economy in 2008. From this total, US$118 billion is channeled to stimulate household consumption and US$50 billion to business investment. These measures were enacted in February and should impact the economy, especially in the second and third quarters of the year. Additionally, measures were approved targeted to the residential real estate market in the country, to increase the liquidity of mortgage bonds that back up credit to purchase upscale residences.

With reference to the fi rst quarter of 2008, the most likely scenario seems to be an stagnant economy, or even an effective output contraction. The rise in petroleum prices, which has a negative effect on disposable earnings in the U.S., the tightening conditions of access to credit by households and, more recently, also by the corporate sector, and continued decline in house prices, all this contributes to discouraging consumers´ spending and aggregate demand as a whole. On the other hand, the strength of U.S. exports and the effects of fi scal and monetary incentives (although these are mitigated by rising credit spreads) act to reduce the contractive pressures. Even with these mitigating factors, the highest risk still seems to be that of a more accentuated slowdown, especially if the fi nancial sector diffi culties worsen.

In the Euro Area, tensions in the credit market and energy price increases contributed to hold back consumption growth, inducing a slowdown of economic growth in the region, though not anticipated at the moment of the actual

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Figure 4.3 – Contribution to US GDPp.p.

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risk of economic contraction. In fact there are signs that the industrial production and in the German construction sector started the year at an intensive pace which should promote the general level of activity in its economy, the main bloc. In Japan, the acceleration of GDP growth in the last quarter of 2007 refl ected the annualized growth at 12.1% of nonresidential private investment, against 4.5% in the previous quarter. In the same direction, the country’s exports increased 12.1% in the period, while expansion of imports of goods and services reached 1.9%; there are, however, signs of weakening of consumers´ confi dence as a result of rising stock market volatility and petroleum prices.

It should be noted that the labor market continues to grow both in the Euro Area and in Japan, economies where the profi tability of companies continues encouraging the will and the ability to invest, as indicated by companies´ and consumers´ confi dence indicators which, even showing a relative decline, stand at a level consistent with a moderate growth scenario. However, risks associated to restrictions due to increases in petroleum and foodstuff prices, persist with regard to the growth of household spending.

Chinese GDP grew 11.2% in the last quarter of 2007, against the same period in the previous year, representing the fourth consecutive result higher than 11%, in this type of comparison. One should highlight that these results occurred even in an environment of restrictive measures adopted in the management of monetary policy and gradual deceleration of growth in exports from the country to the United States which, after increasing 20% in the fi rst quarter, expanded 10.7% in the fi nal quarter of 2007, against the same period in the previous year.

4.2 Monetary policy and inflation

At the end of 2007, central banks from large developed economies had been exposed to the dilemma of combating the persistent rise in infl ation, in particular of energy and agricultural commodities, in an environment of reduced credit supply and deteriorating expectations for economic growth in 2008.

Given the increased liquidity demand by fi nancial institutions, before the New Year in mid-December, the central banks from the United States, the Euro Area (ECB), England (BoE),Canada (BoC) and Switzerland (BNS) announced a coordinated, temporary action in their monetary markets, and

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Figure 4.5 – USA – Energy InflationAnnual growth%

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Figure 4.4 – China – GDP1/


began to carry out public auctions of credit at lower rates than those available from their discount windows. These operations, which combine the acceptance of a larger range of collateral and extended terms for the resale of papers, were added to the effort of reducing the pressure on dollar in the offshore interbank market, which led to the establishment of swap lines between the Fed and BCE (US$20 billion) and between the Fed and BNS (US$4 billion). Whether in Europe or in the United States, the auctions were, at least initially, effective in reducing the spreads between 3-month interbank rates and the target for basic interest rate.

In the United States, besides the implementation of the Term Auction Facility (TAF), to tackle the credit shortage and economic slowdown, the Fed continued its monetary easing initiated in September, cutting off between December and January, the target to the Fed Funds and the discount rates by 150 b.p. One should highlight that half of this decrease occurred in an inter-meeting period, unprecedented decision since 1984, and adopted in a negative real interest scenario, defl ated by Consumer Price Index (CPI). In fact, the cut in interest rates occurred in an environment of growing infl ation that, measured by consumer prices, closed at 4.3% in twelve months until January, the highest rate since 2006, while the annual index of the core personal consumption expenditures, on the increase since September 2007, varied 2.2% in the period.

In the Euro Area, despite the cutback in the growth estimates of the region’s product, the ECB assesses that the decrease in the unemployment rate and growing infl ation pressures – the cumulative 12-month consumer price index variation reached successive records of 3.2% in January and 3.3% in February – do not justify any cuts in the basic interest rate, maintained at 4% since July 2007. In fact, the BCB´s announcement had been emphasizing that the priority is still to fi ght infl ation, not to stimulate economy. The credit data from the Euro Area continues to show strong expansion, although part of the growth in the credit portfolio of banks refl ects an involuntary process of re-intermediation. Additionally, the ECB staff forecasts point to persistent infl ation rates relatively high in view of the 2% ceiling in 2008 and 2009.

Moderate wage increases have been one of the important factors for fighting inflation in Europe. In this context, information that wage campaigns in Germany, whose economy remains robust, would be particularly aggressive this year may raise concerns of European monetary authorities.

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Figure 4.6 – Agricultural Index31.12.2004=100


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Figure 4.7 – Real interest ratesAnnual rates – deflated by CPI%

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Figure 4.8 – USA – Inflation Annual growth%

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In Japan, confi rming the limited exposure of this economy to the effects of the crisis in the subprime segment of the US real estate market, the Bank of Japan (BoJ) maintains the overnight call rate at 0.5% since February 2007. This stance is consistent both with the recent evolution in prices – the core infl ation, which in Japan includes the pressures of petroleum prices, grew 0.8% in the twelve months ended in January, the highest variation since August 2006 and with the scenario which incorporates the yen appreciation against the dollar and forecasts of a downturn in the pace of economic growth.

In the United Kingdom, despite increasing inflation trajectory registered since mid-2007, reaching 2.2% in the twelve-month period ended in January 2008, the BoE’s Monetary Policy Committee, considering the rising risks of an economic downturn, carried out, in December, the fi rst cut of the repo rate in two years, a decision repeated in February, when the rate was set at 5.25% per year. Pressures stemming from rising energy costs (particularly natural gas) and foodstuffs should fuel infl ation throughout 2008, but moderate increases in wages tend to mitigate the second round effects of such pressures.

In China, fi nancial market liquidity remains high, despite restrictive monetary policy adopted by the People’s Bank of China (PBC), which raised the rates of the reserve requirement ratio and of basic rate, standing at 7.47% since December, by 550 b.p and 135.b.p. respectively, during 2007. In this scenario, where twelve-month infl ation reached 7.1% in January, a record level since the past eleven years, the priority continues to be the one of reversing the infl ationary pressure. In this context, the Chinese authorities announced that they will pursue a 4.8% infl ation target in 2008. However, the reductions in the basic rate by the fed in the last months may act as a relatively restrictive element to strengthen the policy of raising interest rates by PBC, which might represent an additional element for attracting foreign capital into the country. In this scenario, the prospects point to new increases in the reserve requirement ratio, an intensifi cation of monetary sterilization, a possible acceleration of foreign exchange appreciation and continued adoption of administrative measures, such as temporary freeze of some prices in the groups of energy, food and transportation.

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Sources: Fed, ECB, BoJ, Bank of England and The People`s Bank of China

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Figure 4.10 – Official interest ratesAnnual rates%

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Figure 4.9 – Consumer inflation Annual growth%

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4.3 International financial markets

The fi nancial turmoil that was set since the crisis in the subprime market impacted the banks´ stance as regards to the requirements for granting new credits, both to trade and industry and to households. The greater rigor adopted in the analysis of such grants refl ected the expansion of prospects of lower growth in borrowers´ incomes and signifi cant accounting write-offs registered in the balance of fi nancial institutions. On the other hand, the demand for credit in these segments also weakened.

The signifi cant write-offs registered in the balance sheets of important banks mostly headquartered in the northern hemisphere, as well as expectations of new write-offs to be carried out during 2008 impacted the growth in premiums of credit default swap (CDS) of these banks. At the end of February the average premium of the CDS of five important banks in the United States and fi ve important European banks reached 134 b.p. and 107 b.p., respectively, compared to 61 b.p. and 46 b.p., in November 30. One should highlight that at the end of May 2007, the CDS of the same banks registered, in the same order, averages of 14b.p and 7 b.p. The credit deterioration environment observed in the fi nancial institutions continues to occur in the corporate sector. Accordingly, the iTraxx Crossover and Dow Jones CDX US Crossover, which measure the required premiums to guarantee credits of European and American companies with risk rating below investment grade, moved from 298 b.p. and 252 b.p., respectively, in the end of November, to 541 b.p. and 396 b.p. in February 29.

Since the last infl ation report, the demand for long-term government papers continued strong, indicating the strong liquidity squeeze, the asymmetry of information regarding fi nancial losses that still lie ahead and the perception of growing risk aversion. The increased demand for papers considered safe, in an environment of adoption of less restrictive monetary policies, favored the maintenance of the falling trend of annual interest rates from ten-year government bonds on the part of major economies, initiated in last July. Accordingly, the monthly average of the annual earnings on papers with regard to the United States, Germany, United Kingdom and Japan decreased between February and November of the previous year, by 43 b.p., 24 b.p., 17 b.p. and 11 b.p., respectively.

It should be noted that, despite this movement, the slope of the term structure of interest rates rose considerably in the

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Figure 4.13 – Yield on government bonds1/


USA, a behavior consistent with a deteriorating outlook for infl ation, which seems to be corroborated, to some extent, by the trajectory of infl ationary expectation measures based on assets prices.

The Chicago Board Options Exchange Index (VIX), which measures the implied short-term volatility of Standard and Poor’s (S&P500) and is considered as an indicator of risk aversion, registered signifi cant variation during the quarter ended in February, when it reached the average of 24.3 points, against 22.3 points in the quarter ended in November. The VIX moved from 22.9 points, in November 30, to 26.5 points, in February 29, registering its maximum value of 31 points in January 22.

The Emerging Market Bond Index Plus (Embi+), a risk indicator associated to emerging markets, maintained, in the quarter ended in February, its upward trend initiated last June, remaining at 291 b.p. at the end of that month, against 250 b.p. on November 30. In the same period, the Embi+ associated to South Africa, Brazil, Turkey, Mexico and Russia registered increases of 101 b.p., 45 b.p., 66 b.p., 24 b.p. and 35 b.p., respectively.

The indexes of the leading stock exchanges dropped, in the quarter ended in February, in response to reported and potential accounting write-offs for major fi nancial institutions and to the expectations of reduction in corporate profi ts in view of the prospects of deterioration in the economic scenario of the leading economies. Accordingly, Dow Jones, Financial Times Securities Exchange Index (FTSE 100), Deutscher Aktienindex (DAX) and Nikkei indexes dropped, respectively, 8.3%, 8.5%, 14.3% and 13.2% between the ends of November and February. Compared to last June 30, some days before the beginning of the turmoil due to the crisis in the North-American mortgage market, these indicators registered, in the same order, falls of 8.5%, 11%, 15.7% and 25%.

The stock exchanges of emerging countries turned in a heterogeneous performance in the quarter ended in February, with the Istanbul Stock Exchange National 100 Index (XU100) from Turkey, Shanghai Composite Index from China and Index of Precios y Cotizaciones from Mexico, registering respective losses of 17.4%, 10.7% and 2.9%; and while Brazil’s Ibovespa index registered an increases of 0.8%. Compared to June 30, 2007, results’ heterogeneity are even bigger, with the stock exchanges from Brazil and China registering, in the order, increases of 16.7% and 13.8%, whereas the indices from Mexico and Turkey decreases of

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Figure 4.15 – Emerging Markets Bond Index Plus

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Figure 4.17 – Stock exchanges – Emerging markets 12.31.2003 = 100


7.2% and 4.9%, respectively. In the year, until February 29, the Ibovespa fell 0.6% and the Shanghai Composite accumulated losses of 17.4%.

The variation of the U.S dollar against other major international currencies refl ected both the monetary easing implemented by the Fed and the increase of investor risk aversion, highlighting that its variation against the yen, a widely used currency, together with the Swiss Franc, in the carry trade operations, evinced, to a large extent, the reversal of those operations, in an environment of high risk perception. Between late November and late February, the dollar depreciated against the Euro, 3.6%, and to Yen, 6.7%, and appreciated 3.4% against the Pound Sterling. Compared to the 12-month period fi nished in February, the dollar depreciation against these currencies reached, in the order, 13.3%, 14.3% and 1.3%.

The dollar appreciated both against the South African rand, 15%, and the Turkish Lira, 3.1%, in the quarter ended in February, a period in which it depreciated 5.9% against the Real. Considering the 12-month period ended in February, the dollar depreciated 19% against the realand 11.7% against the Turkish Lira, and appreciated 10.8% in comparison to the rand, indicating that in the fi rst two months of the year the dollar appreciated 14.1% against the South-African currency, indicating the worsening in economic fundamentals of that country, which is going through severe diffi culties as to energy supply.

In China, although the daily volatility of the renminbi versus the dollar is limited to 0.5%, in both directions, the Chinese currency appreciation, translating the combination of rate decrease of the Fed funds and the increase of the basic interest rate in China, continues at a faster pace. Considering the periods of three and twelve months ended in February, the renmimbi appreciated respective 3.9% and 8.2% against the dollar.

4.4 Commodities

The world economic performance in the past few months, even incorporating the slowdown of the United States´ economy, continued putting pressure on prices of the main commodities, a movement accentuated in some markets by low levels of current stocks. There are also signs of some speculative activities in the commodity markets, which would be used by international investors as an instrument of protection against infl ation.

Figure 4.18 – Dollar exchange rates6.1. 2005 = 100

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Figure 4.20 – Renminbi/dollar exchange rateMonth valuation – Average 1/%

Fonte: Bloomberg1/ Up to February 29, 2008.


The international prices of agricultural commodities show a 31.8% increase between late November and late February, driven by increases in prices of sugar, 49.3%; cocoa, 40.9%; soybean, 39.9%; corn, 38.9%; coffee beans, 29.8%; cotton, 25.9%; and wheat, 22.3%. The price increase of soybean, wheat and corn continued associated to structural factors – use of corn as a raw material for ethanol production in the United States and competition for planting area of soybean and wheat –, with effects on the levels of their world stocks. The price of coffee beans has refl ected, equally, reduced stock levels, in an environment of pressing international demand for the product.

Metallic commodity prices remain consistent with the world economy’s pace of activity. The average increase of 20.7% registered between the ends of November and late February, refl ected, to a large extent, the increase in prices of precious metals, 23.5%, in particular gold, 21.5%; aluminum, 24.6%; copper, 23.2%; and nickel, 17.2%. One should highlight that the agreement, which prevails for one year, between one of the largest mining companies in the world and major Asian steel mills, involving the rise in prices of iron ore by up to 71%, which, upon constituting a parameter in the negotiations among the other iron ore producers and consumers, in an environment of strong demand growth, especially in China, should promote the prolonged rising pressures on iron ore prices.

4.4.1 Petroleum

The continued upward trend in international oil prices reflects, essentially, the weakening of the U.S. dollar compared to major currencies, the reluctance of the Organization of the Petroleum Exporting Countries (Opec) in raising its production, the decline in the US stocks and the recent decrease in Nigerian output In this scenario, after remaining at a level higher than US$90 since the end of November 2007, the prices per barrel of WTI and Brent type of petroleum, reached in the order, US$101,84 and US$100,15, at the end of February, after setting respective records of US$102,59 and US$100,95, on February 28.

4.5 Conclusion

The deteriorating process to which the international fi nancial markets have been submitted should continue, possibly intensifying in the next few months, considering the effects of the subprime market crisis on the confi dence in other

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Figure 4.21 – S&P GSCI agricultural commodity price index

Figure 4.22 – Oil – Spot marketUS$ per barrel

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complex fi nancial structures, translated both in further reduction in liquidity as in increasing price volatility in a variety of debt markets, fueling uncertainties regarding the exposure of major banks and other market participants.

The prevailing uncertainties in the financial markets negatively impacted the real sector of the leading developed economies, particularly the United States,. In this scenario, the performance of the domestic demand in Europe and Japan, as well as in China and other large emerging economies, starts playing an increasingly important role for the general conditions of international trade and worldwide output growth in 2008.

The upward movement of infl ation should continue, fueled by persistent increases in commodity prices, particularly petroleum, which translates into increasing risks of pass-through from full infl ation to core infl ation. In this scenario, the management and communication of the monetary policy become particularly challenging.


The International Financial Crisis – Summary on the Action of Central Banks

The expanded liquidity registered in the global fi nancial markets during recent years was interrupted by mid-2007. The signifi cant increase in delinquency in the North-American mortgage market and the uncertainty over the potential losses to the fi nancial system caused substantial restriction of fi nancing, initially in the US banking system itself, and at a second moment, in the international context.

Since then, the uncertainty derived from the asymmetry of information, the expansion of risk perception and the re-pricing of assets caused the fi nancial markets to alter their preference for liquidity and restrict credit even further. In this environment, market volatility reached a historically high level, shown by the evolution of the Chicago Board Options Exchange Volatility Index (CBOE VIX), which moved from 13.1 points at the end of May to 30.8 points on August 16, 2007.

In this context, the markets started testing the central banks’ effort to prevent the expanded preference for liquidity to translate in multiplication of bankruptcies. The monetary authorities from the United States, Euro Area, Japan, Australia, Russia, Canada and Switzerland, among others, acted, by means of expanding open market operations, in order to prevent the corresponding effective overnight rates from keeping above the pre-established targets, and the risk of systemic bankruptcy of funds and, possibly, of banks from expanding.

Between August 9 and 10, the central banks of the largest economies injected US$292 billion in the market, with emphasis on the actions by the European Central Bank (ECB), US$213 billion; by the Federal Reserve System (Fed), US$62 billion;


Bank of Japan (BoJ), US$8.5 billion; and the Reserve Bank of Australia, US$4.2 billion. Additionally, the Fed, upon disclosing alteration in its balance of risks between infl ation and activity level, a week later reduced the rediscount rate from 6.25% p.y. to 5.75% and expanded from one to 30 days the repurchase commitment of papers accepted as collateral which, just as observed with the Bank of Canada (BoC), were diversifi ed.

The actions taken by the leading central banks contributed in such a way that, in general, up to the beginning of September, the crisis effects over the largest banking institutions were limited, despite the correction in progress amidst the fi nancial markets. However, by mid-September, in face of a new episode of deteriorating credit conditions, the Fed was compelled to intensify its actions and, for the fi rst time since June 2004, reduced both the target for the Federal funds, since then by 4.75% p.y., and the rediscount rate, then at 5.25% p.y. Subsequently, the four largest US banks utilized US$500 million, each, from the credit line offered through the rediscount window. For the same reasons, in October, the Fed would again reduce by 25 b.p. the target for the Fed funds.

However, during the fourth quarter of 2007, with the consolidation of the increases in the prices of energy and foodstuffs, the central banks turned to face the controversial task of preventing the systemic aggravation of credit supply and anchoring the infl ationary expectations, avoiding the expansion the moral risk and seeking to preserve their credibility in combating infl ation.

In this sense, in an action diverse from those adopted by the Fed, ECB, while it persisted emphasizing the need for anchoring the infl ationary expectations, preserved its stance of maintaining the basic interest rates initiated in July.

At the end of 2007, with the increasing degree of uncertainty in the international economy, the leading central banks were again urged to mobilize in order to expand the fi nancial system’s liquidity, reduce the upward pressures in the interbank markets, and revert the negative expectations and, thus diminishing the global economic downturn already announced for 2008.


In December, for the third time in the second half, the Fed would turn to reducing the target for the basic interests, which would end the year at 4.25% p.y. In the same month, the United Kingdom, the Monetary Policy Committee (MPC) of the Bank of England (BoE), despite rising infl ation, conducted the fi rst reduction of the repo rate in over two years.

Pursuant to the new aggravation of the crisis, on December 12, in a coordinated action, the Fed, ECB, BoE, BoC and the Central Bank of Switzerland (SNB) announced the establishment of temporary interventions (injecting liquidity) in their markets. Led by the Fed, these fi ve institutions launched a joint action to offer resources at rates below those accessible through the respective rediscount windows, to disseminate liquidity more effi ciently, to reduce the monetary market stress and to seek the reversal of the crisis scenario.

In the United States, the Fed turned to acting in two fronts. First, to expand credit facilities and reduce the short-termfi nancing pressures, the monetary authority implemented the Term Auction Facility (TAF). Those are temporary credit operations, with interests between those practiced in the open market and in rediscount operations, in which the Fed expands the range of collateral papers and extends both the maturity term of the loans, 28 or 35 days, and the number of eligible institutions, from 20 dealers to likely 8,000 depositors with the monetary authority.

The first auction took place on December 17, registering offer of US$20 billion, to 28 days, with the resources being procured at the cutoff rate of 4.65% p.y., on the part of the 93 participants, who, altogether, demanded some US$61 billion. Three days after, in a new auction for the same amount, this time for 35 days, the cutoff rate reached 4.67% p.y., with acquisition of some US$58 billion by the 73 requestors.

In line with the guidelines established by the coordinated action among central banks, similar operations for relief of pressures on the fi nancial markets were undertaken by the BoC, on December 13 and 18, by the BoE, on December 18 and January 15, by the ECB, on December 17 and 20, and by SNB, on December 17.


Besides these operations, still in December and for an initial period of six months, the Fed, aiming at reducing the pressure on the US dollar in the offshore interbank market, created swap lines with the ECB (US$20 billion) and with the SNB (US$4 billion).

At the beginning of 2008, the Fed, the ECB and the SNB, expanding its initial forecasts, renewed its interventions in the markets. Although they have not intensifi ed the auctions in local currency, the ECB and SNB turned to making use of swap lines established with the Fed.

According to the Fed’s assessment, the result of these actions has been so positive that it may be possible that the TAF auctions will be defi nitively incorporated to the available instruments of monetary policy. In fact, the spread between the interbank and the target for the Fed funds drastically reduced in December and returned, in February, to the level that prevailed in the fi rst half of 2007, before the start of the subprime sector crisis.

In a second action frontline, mostly directed towards improving agents’ expectations, fi ghting recession risks and reactivating the labor market and consumer expenditures, the Fed, despite the infl ationary surge, cut off the target for the Fed funds by 125 b.p. in January, a movement similar to that registered in rediscount rates. One should highlight that the reduction by 75 b.p., carried out on 22, was both the fi rst inter-meeting decision since September 2001 and the largest cut since 1984, an outstanding move when one considers that at that time the real interest rate reached 7% p.y., while in January, considering the consumer price index as defl ator, it reached -1.2%.

Also in January, the Fed turned to acting with local fi nancial system aiming to reduce tensions in the short-term fi nancing market. For the 14th and 28th, the TAF auction offering was expanded to US$30 billion, each, resulting in a falloff of cutoff rates to 3.95% and 3.12%, respectively, in both cases for more than fi fty requestors. In February, new offers of US$30 billion took place on the 11th and 25th.

In the United Kingdom, despite infl ation continued to climb since August 2007, the movement indicated by the twelve-month variation of 5.7% observed,

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2.53.03.54.04.55.05.56.0

3.132007

5.24 8.6 10.17 12.28 3.112008

Fed funds target (a) 3 months interbak rate (b)Spread (b-a) right axis

% p.y.

Figure 1 – USA – Interbank and Fed funds target spread % p.y.



in January and February, by the producer price index, the highest rate since the early 90’s, BoE has maintained its assessment that the risks of reduced growth remain more important and, in this sense, it started reducing the repo rate in February, in a move similar to that undertaken by the BoC, both in January and in March.

At the beginning of March, tensions in the monetary markets demanded new actions by the leading central banks. In the United States, on March 7, the Fed expanded the value of TAF operations to US$50 billion, each, defi ning the next interventions for the 10th and 24th of the month. In the fi rst of them, the cutoff rate dropped to 2.8% and the ratio between offers received and accepted reached 1.85. In the same communiqué, on March 7, the Fed not only extended for another six months the duration of the TAF auctions, but also gave signs of the possibility of new expansion in the volume of offers.

Still on March 7, the Fed established a series of term repurchase operations, aimed specifi cally at the dealers, with potential impact of up to US$100 billion. In the context of these operations, one should highlight the extension of the overnight maturity to 28 days and the acceptance of the use of any bonds as collateral in open market operations, meaning the swap, by the Fed, of treasuries for debts by federal agencies, including mortgage-backed bonds.

On March 11, in view of reduced liquidity in its short-term fi nancing system, the Fed created a program of term asset-backed loans (the Term Securities Lending Facility – TSLF). By this new operational modality, the monetary authority turns to offer, no longer as overnight, but for 28 days, up to US$200 billion in treasuries to its dealers (institutions, not necessarily depositors, as required in the case of TAF auctions) in exchange for papers including federal agencies bonds, residence mortgage-backed federal bonds (the mortgage-backed securities – MBS) and, even, mortgage bonds issued by private institutions, provided they are rated AAA.

These auctions of bond swaps, forecasted to start on March 27, will be held on a weekly basis and should expand the dealers´ liquidity, possibly full of AAA-type private mortgage-backed bonds which, despite


being investment-graded, were non-liquidated on the market and were not traditionally accepted by the Fed. Coupled with the interventions of day 7, these new means of liquidity supply may expand it by around US$400 billion (US$100 billion in TAF, US$100 billion in repurchase agreements and US$200 billion in TSLF).

Also on March 11, the leading central banks resumed their joint action aimed at reducing the pressures on the global monetary markets. The ECB and SNB announced the renewal of the use of the respective swap lines with the Fed. This new joint action expanded the amounts to US$30 billion in the Fed-ECB line and US$6 billion in the Fed-SNB line, while the effectiveness of the swaps was extended until September 30.

More recently, the Fed intervened directly in the acquisition of Bear Stearns by J.P. Morgan, since that bank’s independence proved to be unfeasible under the current market conditions.

In the United Kingdom, where the spread and the three-month libor and the BoE basic rate, the repo rate, returned, in February, to December levels, the monetary authority announced the expansion of the list of collateral for the rollover of the three-month repo operations. In this sense, it disclosed that it would raise to £10 billion the operation foreseen for March 18, leaving, however, open, the rollover amount scheduled for April 15.

The BoC, proceeding with the liquidity supply to its fi nancial market, announced that it will launch another two temporary purchase and resale agreement (Term Purchase and Resale Agreements – TPRA), both with a grace period of 28 days and for the value of C$2 billion, the fi rst of which for March 20 and the second, for April 3.

In the Euro Area, although the ECB action, in line with the a lesser exposure of the region’s economy to the effects of the fi nancial markets crisis, is not so aggressive as that of the Fed, its decision must adjust to the scenario of worsening credit crisis and to the risk of economic deceleration. These factors have inhibited the more vigorous performance of ECB in curbing infl ation which, considering the latest twelve

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4.0

4.5

5.0

5.5

6.0

6.5

7.0

3.312005

8.31 1.312006

6.30 11.30 4.302007

9.28 2.292008

Repo rate (a)Interbank 3 months (b)Spread (b-a) axis to the right

% p.y.

Figure 2 – United Kingdom – Interbank and repo rate spread % p.y.

Fonte: Thomson Datastream


months, reached the record level of 3.3% in February 2008, despite the strengthening of the Euro.

The central banks from the leading Asian economies, less exposed to the effects of the subprime market crisis, have not followed the interventions initiated by the Fed. In this sense, in Japan, the BoJ continues ensuring the adequate functioning of the local monetary market through ordinary interventions suffi cient to assure the necessary supply of funds.

On the other hand, in China, very different liquidity conditions and a strong inflationary surge have demanded restrictive monetary actions on the part of the central bank.

Table 1 – Chronology of interventions

Date Central Bank Actions

August 9-10, 2007 Fed, ECB, BoJ and RBA Inflows totaling around US$300 billion through repurchase agreements.

August 17, 2007 Fed Reduction of rediscount rates to 5.75% and extension of maturity terms of these

operations to 30 days.

September 18, 2007 Fed Reduction of Fed funds and rediscount rates to 4.75% and 5.25%, respectively.

October 31, 2007 Fed Reduction of Fed funds and rediscount rates to 4.50% and 5.00%, respectively.

December 2007 Fed, BoC and BoE Reduction of basic interest rates, the first reduction implemented by the BoE in two years.

As of December Fed, ECB, BoE, BoC Significant inflow of resources through term auctions, known in the U.S. as Term Auction

12, 2007 and SNB Facility (TAF), operations with extended maturity terms that accept a broader range of collateral.

As of December Fed, ECB and SNB Setting up of swap lines denominated Fed-ECB and Fed-SNB.

12, 2007

January 22, 2007 Fed * In an extraordinary meeting, the Fed cuts Fed funds and rediscount rates by 75 b.p.

(to 3.5% and 4%, respectively).

January 30, 2008 Fed Reduction of Fed funds and rediscount rates to 3.00% and 3.50%, respectively.

January Fed Widening of TAF operations to US$30 billion each.

January BoC Reduction of basic interest rates.

February BoE Reduction of the repo rate.

March BoC Additional reduction of basic interest rates.

March 7, 2007 Fed Extension of TAF auction validity and widening of its amount to US$100 billion. Supply of

US$100 billion in TAF operations through placement of repurchase agreements in

exchange for collateral that included even mortgage-backed bonds.

March 11, 2008 Fed Placement of up to US$200 billion in term securities for dealers in exchange for a wider range

of papers, including mortgage bonds issued by private institutions.

March 11, 2008 Fed, ECB and SNB Additional 50% placement of swap lines (Fed-ECB and Fed-SNB) with extended maturities

(up to September 2008).

March 11, 2008 BoE Widening in the range of collateral accepted and increment in the value (£10 billion) of 3-month

repo operations.

March 11, 2008 BoC TPRA renewal for more than C$4 billion.

March 15, 2008 Fed Fed direct intervention in the Bear Stearns acquisition by J.P.Morgan.


In summary, even if in a non-conclusive manner, 2008 seems to be the year of progressively confl ictive decisions for the central banks of the United States, the Euro Area, Japan, and the United Kingdom. On the one hand, these should act in order to favor the expansion (or mitigate contraction) of credit supply in a scenario of recession or of strong downturn of economic activity. Conversely, the high utilization of installed capacity and the growing pressures over prices act in the sense of inducing these central banks to combat the infl ationary exacerbation and a possible deterioration of their credibility, mostly because the hikes in the prices of petroleum and foodstuffs have proven to be more structural than episodic. Unquestionably, in 2008 it is expected a scenario in which the monetary authorities will manage the monetary policy with a reduced degree of freedom.

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