Morgan Stanley - The Peloton, the "Elastic Band Effect" and Monetary Policy

Major central banks have recently talked down some of the hikes in policy rates priced in by markets. On our forecasts, the ECB and the Fed will likely hike rates only in 2Q10 and 3Q10, respectively. Other central banks have a choice: join the monetary peloton and hike along with the major central banks or join the breakaway group led by the Bank of Israel. Both strategies carry risks. Hiking early gives central banks more control of their hiking cycle, but it also makes policy less effective and puts pressure on the currency to appreciate.

Further, when the major central banks start hiking policy rates, early hikers may have to pause or slow down their tightening campaign. Hiking in tandem with the major central banks allows central banks to exploit local and global excess liquidity, but will likely require rapid adjustments to their preferred policy path. Norges Bank and the RBA are likely to join the breakaway group in 4Q09. The majority of AXJ central banks, despite having the best-performing economies, are likely to hike only in 3Q10. p 2

Central Bank Watch

Euro Area: Easy Does it for the ECB. p 7Japan: Libor Spread Inversion Implications. p 8Sweden: Still Softly, Softly. p 8Australia: An RBA Hike Before Year-End?. p 9Russia: Anticipating Another Cut - Sep. 11?. p 9Poland: Easing Bias Survives, Not for Long. p 10Turkey: Transmission Mech. Slow but on Move. p 10South Africa: On-Hold Stance Likely in Sep. p 11India: Cutting Agriculture Output Estimates Again. p 11Korea: No Urge for Rate Hikes. p 12Malaysia: Beyond the Inventory-Led Rebound. p 12Brazil: Fiscal Challenges. p 13

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Morgan Stanley - The Global Monetary Analyst. The Peloton, the "Elastic Band Effect" and Monetary Policy 02.09.09

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