The World Beyond the Fed

In the runup to the eagerly awaited FOMC meeting on Sept. 18, we take a look at rate conditions and central banks around the globe

Editor's note: This is an updated version of a BusinessWeek story originally published Sept. 13.

The world's investors are focused on one man and one date. On Sept. 18, Federal Reserve Chairman Ben S. Bernanke will meet with the Federal Open Market Committee to decide whether to cut interest rates—a move ardently desired by the markets after a summer of turmoil. Bernanke has had to wrestle mightily with the big questions of inflation, recession, and liquidity as the date nears. He is the central banker to watch. Yet he's not the only central banker struggling with weighty decisions.

Look beyond the Federal Reserve—and to some extent the European Central Bank—and you'll find a host of central banks in Europe, Asia, and Latin America trying to read the tea leaves. And they're not necessarily dealing with the same pressures as the Fed boss.

Bernanke may have to cut rates to forestall a recession triggered by a U.S. housing slump and the liquidity crisis. But other central bankers are feeling pressure to hike rates to stem too-strong growth. And while the U.S. economy has an impact beyond its borders, so do other major economies. The most notable: China, whose demand for goods and commodities exerts an influence on countries as close as South Korea and as far away as Australia.

Here's a guide to the other central banks and the decisions they face:


The People's Bank of China has fought for months to contain inflation, and it has not been able to dampen the country's red-hot growth. On Sept. 14 it raised the one-year rate to 7.29%, a nine-year high. It also has ordered banks to increase their reserves even more to help curb excessive lending and to soak up cash.

Unlike the Fed, yet another rate hike is looking likely for the PBOC. Inflation is shooting up to an annual rate of 6.5%, and China's August trade surplus widened 33%. Food prices are jumping. The stock market has more than doubled this year. Now analysts think another rate hike before yearend is needed to deflate the stock bubble, tame inflation, and rein in growth.


While the talk in the U.S. and elsewhere is about rate cuts, in Australia the central bank is likely to keep on raising rates, which are already at a six-year high. The Australian economy continues to grow at a fast clip, thanks largely to China and India's continued appetite for iron, zinc, copper, and other commodities. Employment numbers for the month of August were strong. One big problem for more rate hikes is timing: Prime Minister John Howard faces an election soon, and rate hikes are always unpopular.


The market turmoil has definitely complicated things for the Bank of Japan. It wants to raise the benchmark overnight rate from 0.5% as soon as possible for a number of reasons. The BOJ hates how low rates encourage the yen-carry trade; it wants to "normalize" rates, i.e., narrow the gap between Japan's rates and those of other industrialized countries; and it wants to send a signal to markets that it won't tolerate inflation.

But the BOJ is stuck because it fears that a rate hike might spark a sudden shift in global money flows, rattle investors, and make life difficult for other central bankers. That was evident last month when the BOJ left rates unchanged, though some economists think the bank might shift its stance later this month or next. Other factors to consider: Japan's GDP contracted slightly in the latest quarter. That might stay the BOJ's hand. So might the political turmoil that resulted in the abrupt resignation of Prime Minister Shinzo Abe.


Despite the won's 20%-plus appreciation against the dollar in the past three years, Korea has managed to post double-digit export growth thanks to brisk shipments of steel, petrochemical products, ships, and machinery to emerging economies. The strong export performance has allowed the Bank of Korea to place top priority on controlling prices at home. That's why in early September it decided to maintain its base interest rate at 5% after increasing it by 25 basis points each in July and August. The rate compares with a low 3.25% just two years ago.


India's Reserve Bank governor, Y.V. Reddy, is between a rock and a hard place. GDP growth at 9.3% is stellar but also worrying. His biggest concern: the unprecedented amount of foreign investment flows coming into the country—reserves are at a high of $228 billion—and an overheated domestic economy that is fueled by consumer demand. Reddy can't lower interest rates to control foreign capital inflows or the economy will catch fire, while raising interest rates will bring in even more foreign money to fuel a possible stock bubble. As India is increasingly integrated into the global economy and dependent on global risk capital, the bank could find itself sacrificing growth for stability.


No one doubts Bank of England Governor Mervyn King's credentials as a top-flight macro-economist. But just how focused he is on the health of the City, London's financial center, has always been open to question. Such doubts have increased during the current credit freeze. While foregoing a once widely expected interest rate increase this month, the Bank has been slower than either the ECB or the Fed to add liquidity to the system, though it has now begun doing so.

King warned on Sept. 12 that pumping money into the banking system could encourage excessive risk-taking, sowing the seeds of the next crisis. Yet industry figures also think that the bank handled recent standby borrowings by Barclays poorly. The BOE's silence on the reasons for the borrowings—which Barclays says were technical—led to worries, which have eased, that Barclays was experiencing liquidity problems—something that would have been an extremely ominous development in the current circumstances.


The Swedish economy is thriving on high-tech exports and robust consumption at home. The central bank raised rates a quarter-point on Sept. 6, to 3.75%, and indicated an inclination to increase further.


The Mexican central bank has done an excellent job keeping the economy crisis-free for years. Because the country's economy often follows U.S. trends so closely, rates tend to rise and fall similarly to those of the U.S., but in recent months the Central Bank has been cautious about easing too much: It does not want to trigger a round of inflation that would be difficult to snuff out later. The Mexican Fed, by the way, doesn't raise and lower rates the way the U.S. does. It simply sends signals to the market by the way it handles weekly auctions of government bonds.


The global credit crunch has had a fairly big impact on Russia, though it is expected to be temporary because of Russia's strong macro fundamentals and relatively low levels of debt. The central bank has been forced to intervene heavily over the past few weeks, in response to an outflow of short-term foreign capital. In August there was a net private-sector capital outflow of an estimated $5.5 billion. This resulted from foreign investors dumping ruble securities as a result of the predictable "flight to quality."

The capital flight has forced the central bank to intervene in two ways. First, it has had to dip into Russia's foreign exchange reserves to support the ruble. On Aug. 21 alone, the central bank spent $3.4 billion after the ruble fell by 0.6% against a basket of currencies. Second, the central bank has intervened to inject fresh liquidity into the banking system. In the two weeks after Aug. 15, Russian banks borrowed some $30 billion from the central bank, including $10 billion on Aug. 27.

In early September the deputy governor of the central bank forecast that the central bank may have to provide up to $12 billion to $15 billion a day in liquidity to the banking sector during the next three months. It's quite a reversal: For most of the year the central bank has struggled with strong upward pressure on the ruble. Yet foreign exchange reserves are now a gigantic $420 billion, and Russian companies can easily weather a rough patch.

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