Monetary review - 4th Quarter 2000 - Recent Monetary Trends

This review covers the period from September until the middle of November 2000.

International economic background

The robust growth in the global economy continued in the first half of 2000, and prospects are still favourable. In their autumn forecasts both the European Commission and the International Monetary Fund, IMF, have raised their estimates of global growth for 2000 and 2001. However, growth in 2001 is expected to be more moderate, in view of higher oil prices and a tighter monetary policy than at the turn of the year in both the USA and the euro area, as well as Japan.

After very strong expansion in 1999 and the 1st half of 2000 there are now more and clearer signs of a dampening of the US economy to a growth rate more in line with the output potential. The preliminary national accounts thus showed a slowdown in growth in the 3rd quarter. For investments in particular growth was more subdued. Although the growth in labour productivity is still high, it did fall in the 3rd quarter, in step with the economy's dampening. To date, the high productivity growth has made a strong contribution to the relatively moderate course of inflation, despite high growth and low unemployment.

US technology stocks have lately been highly volatile, cf. Chart 1. This especially applies to the NASDAQ Index, which has fallen since the start of the year. This reflects the announcement of downward revisions of earnings expectations by a number of major corporations in September and October. The traditional Dow Jones Index is at around its January level. Since stock prices are considered to be one of the forces driving private consumption, the greater volatility makes it more difficult to assess the trend for private consumption. Indeed, consumer confidence fell in October to the lowest level of the past year, but is still high.

The most recent key economic indicators for the euro area confirm the current economic upswing. GDP in the 2nd quarter was 3.7 per cent above the level in the previous year, which is the highest growth rate since the beginning of 1998. The growth is attributable to continued robust development in private consumption, and in particular to a significant improvement in exports, supported by stronger global growth and the depreciation of the euro vis-à-vis especially the dollar and the yen. Unemployment in the euro area has declined steadily since the autumn of 1997, to a rate of approximately 9 per cent in late summer. However, industrial and consumer confidence indicators have generally fallen in recent months. Together with the more moderate growth in manufactured output, this indicates slightly lower growth in the 2nd half of 2000, cf. Chart 2. In October consumer prices (HICP) in the euro area were 2.7 per cent higher than one year before. The increase thus still exceeds the definition of price stability of the European Central Bank (ECB) as an annual rate of increase in HICP of below 2 per cent in the medium term. The higher rate of inflation is attributable particularly to rising energy prices. Inflation excluding energy and food is still well below 2 per cent, but with a tendency to rise. In September the monetary aggregate, M3, was 5.5 per cent higher than the level in 1999. The growth rate thus still exceeds the reference value for monetary growth of 4½ per cent.

In Japan the emerging upswing continued in the 2nd quarter with a rate of growth of 1.0 per cent against the 2nd quarter of 1999. The expansion is attributable primarily to strong growth in exports and the recent substantial increase in government investments as a consequence of the package of fiscal-policy measures of November 1999. However, a number of indicators suggest diverging economic trends, and therefore considerable uncertainty concerning the strength of the current upswing. Although the industrial and consumer confidence indicators are both rising, the ongoing process of restructuring and renewal of the Japanese corporate sector entails a high degree of uncertainty and tends to dampen demand in the private sector. In Japanese terms unemployment is still high.

Together with the strong dollar the high level of domestic demand in the USA has led to an increase in the already very substantial US current-account deficit, cf. Chart 3. The growing US deficit has to a great extent been financed by direct investments and portfolio investments from abroad where investors are attracted by the rapid pace of technological innovation characterising the US economy. The tendency towards growing imbalances between the USA, Europe and Japan is not sustainable, and the central issue is how balance can be restored. There is a risk of a sudden, extensive correction of exchange rates, which would have major implications for the global economy.

Recent years have seen a net outflow of capital from the euro area to countries such as the USA, via direct and portfolio investments, cf. Chart 4. The development in portfolio investments reflects considerable net purchases of equity securities outside the euro area, whereas the euro area as a whole was a net seller of debt securities in 1999 and until August 2000. There appears to be a tendency of reduced total net outflow of capital from the euro area. It should be noted, however, that the trends for direct investments and equity securities investments in 2000 are influenced strongly by substantial fluctuations in February, when the British telecommunications company Vodafone acquired Mannesmann of Germany via an exchange of shares.

The euro weakened further in the 3rd quarter. Together with the central banks of the USA, Japan, Canada and the UK, on 22 September the ECB intervened in support of the euro. The background was their shared concern about the possible consequences for the world economy of the development in exchange rates. Thanks to this intervention, the euro strengthened immediately from approximately 0.85 dollar per euro to approximately 0.89 dollar per euro, or by just over 4 per cent, cf. Chart 5. The euro rallied forthwith by approximately 5.5 per cent against the yen. In conjunction with growing unrest in the Middle East the dollar strengthened again in October vis-à-vis the euro and the yen. The ECB intervened on a few occasions in the first part of November, in view of the concern about the global and domestic consequences of the euro exchange rate, including its significance to price stability. It was maintained that the external value of the euro did not reflect the favourable conditions in the euro area. In mid-November the euro stood at approximately 0.86 dollar per euro and approximately 93 yen per euro.

In mid-September the ECB announced its intention to sell foreign exchange interest income derived from the foreign reserve assets against euro in order to maintain the structure and risk profile of the ECB's balance sheet.

On 5 October the ECB raised its official interest rates by 0.25 per cent. The minimum bid rate on the main refinancing operations was thus raised to 4.75 per cent, while the interest rates on the deposit facility and the marginal lending facility were raised to 3.75 per cent and 5.75 per cent respectively. The background to the raising of interest rates was the upward pressure on consumer prices stemming from higher oil prices and a greater risk of imported inflation in view of the low euro rate. Despite rising official interest rates and a higher rate of price increases, 10-year bond yields in the euro area have been comparatively stable during the current year, causing the yield curve to level off, cf. Chart 6. The flatter yield curve can be taken to indicate stable interest and inflation expectations.

The 10-year US yield, on the other hand, has been more volatile throughout the year, even though in mid-November the 10-year government-bond yield was unchanged from September at approximately 5.8 per cent.

The 10-year government bond yield in Japan has also shown a high degree of stability in recent years. The yield on Japanese 10-year government bonds has dropped by approximately 0.2 percentage point since the start of September to approximately 1.8 per cent, despite the downward adjustment of the credit rating of Japan's domestic government debt from Aa1 to Aa2 by Moody's, the international credit rating agency.

Growth in the UK economy subsided slightly in the 3rd quarter to an annual rate of increase of 2.9 per cent. In October the unemployment rate was 3.6 per cent, which is the lowest level for 25 years. At the same time a record-high number of vacant jobs was reported to job centres. This combination indicates a very tight labour market in the UK, even though this trend is not yet reflected in the annual rate of wage increases, which has been around 4 per cent since the spring. The increase in the consumer price index excluding housing (RPIX) was 2.0 per cent in October, and thus still below the Bank of England's inflation target of 2.5 per cent. The Bank of England's interest rates have remained unchanged since 10 February.

Sveriges Riksbank has kept its official interest rates at an unchanged level since February. In its most recent inflation report from October the Riksbank estimates growth for the year 2000 at 4.0 per cent, while the inflation rate up to the end of the projection period in September 2002 is not expected to exceed the target of 2 per cent. The Swedish krona has weakened since the summer, to some extent in step with the higher short-term interest rates in the euro area.

With effect from 21 September Norges Bank raised the official interest rates – the current account and lending rates – by 0.25 per cent to respectively 7.0 per cent and 9.0 per cent. The background to the raising of interest rates was the growing risk of higher price and cost increases in Norway than in the rest of Europe, and of a relatively weak Norwegian krone.

Development in interest and exchange rates in Denmark

The result of the Danish referendum on 28 September was the rejection of the removal of Denmark's opt-out from the single currency. Immediately after the result of the referendum was published the Danish government and the Nationalbank issued a joint press release, cf. p. 77, stating that Denmark would continue its fixed-exchange-rate policy within the narrow band of the EU's exchange-rate mechanism, ERM II. The government and the Nationalbank will therefore implement the measures required to maintain and continue the fixed-exchange-rate policy. In his opening report to the Folketing (Parliament) on 3 October Prime Minister Poul Nyrup Rasmussen thus emphasised that the government would not hesitate to introduce measures to tighten fiscal policy if required, in order to maintain the fixed-exchange-rate policy.

To avoid uncertainty concerning the krone rate after the referendum the Nationalbank raised the lending rate and the rate of interest for certificates of deposit by 0.50 per cent to 5.60 per cent with effect from 29 September. The discount and current-account rates remained unchanged at 4.50 per cent.

The krone rate had been under some pressure from the middle of September until the referendum. The krone weakened to kr. 7.4680 per euro, which is the lowest level ever in ERM II, but still well away from the intervention limit of kr. 7.62824 per euro. The Nationalbank had sold foreign exchange for kr. 11.1 billion in September in order to dampen the fluctuations in the krone rate. At the beginning of September the short-term money-market interest rates in Denmark rose by more than 1 percentage point, as opinion polls indicated that a majority would reject the single currency. By far the greatest proportion of the opinion polls concerning EMU participation taken during the summer and up to the referendum had shown a majority in favour of remaining outside the single currency. The result was thus to a great extent already taken into account by the market participants before the referendum.

The 3-month money-market rate peaked at a level close to 7 per cent, with an interest-rate differential to the euro area of approximately 2 per cent. The differential narrowed considerably in the last two weeks before the referendum, and the money-market interest rate fell to a level of just over 0.5 per cent above its level at the beginning of September, cf. Chart 7.

After the referendum and the raising of interest rates the krone strengthened during October to the highest level since January, and the Nationalbank purchased foreign exchange for kr. 16.8 billion. Concurrently the interest-rate differential continued to narrow, and in mid-November the 3-month money-market interest rate was approximately 5.5 per cent, while the interest-rate differential to the euro area was around 0.4 percentage point. The development in the krone rate after the referendum reflects sustained confidence in the Danish economy and in the fixed-exchange-rate policy. Long-term interest rates remained by and large unchanged in the run-up to the referendum, and the yield differential to the euro area for 10-year government bonds fluctuated within the range of 0.35-0.55 per cent.

In view of the development in the ECB's marginal rate for allocation of liquidity in the weekly tenders the lending rate and the rate of interest for certificates of deposit were raised by 0.1 per cent to 5.10 per cent on 27 September, cf. Box 1 concerning the Nationalbank's communication of interest-rate adjustments.

After the ECB in June adjusted the tender procedure from fixed-rate tenders to variable-rate tenders, as an extraordinary interim measure the Nationalbank announced adjustments of the lending rate and the rate of interest for certificates of deposit by issuing press releases. The last press release was issued on 27 September when the lending rate was raised by 0.1 per cent to 5.10 per cent. The intention was to specify that these interest-rate adjustments were a consequence of the interest-rate variations in connection with the ECB's tenders and were not attributable to the development in the exchange rate or the foreign-exchange reserve.

Once this policy was established, the Nationalbank as from 3 October returned to its normal practice, which is to announce adjustments of the Nationalbank's lending rate and the rate of interest for certificates of deposit solely via its on-line information system, DN News, and on the Nationalbank's Web site.

Against the background of the ECB's raising of interest rates on 6 October the Nationalbank raised the discount rate and the current-account rate by 0.25 per cent to 4.75 per cent, cf. Box 2, which describes the relationship between interest-rate adjustments by respectively the Nationalbank and the ECB. In view of the krone's strengthening the lending rate and the rate of interest for certificates of deposit remained unchanged. As an element of the normalisation after interest rates were raised on 29 September the lending rate and the rate of interest for certificates of deposit were lowered by 0.1 per cent on 13 October, and by 0.1 per cent to 5.40 per cent on 27 October.

Denmark's monetary-policy instruments fundamentally consist of two facilities: overnight deposits with the Nationalbank which accrue interest at the current-account interest rate corresponding to the discount rate, and the Nationalbank's weekly market operations, whereby monetary-policy counterparties may place funds and borrow at the 14-day rate. The 14-day interest rate is also called the Nationalbank's lending rate or the rate of interest for certificates of deposit.

In practice, under the fixed-exchange-rate policy, these official interest rates closely follow the development in interest rates in the euro area. The discount rate will thus typically be adjusted when the ECB's interest-rate corridor is adjusted, cf. Chart A.

With effect from 28 June the ECB changed its tender procedure from fixed-rate tenders to variable-rate tenders for allocation of liquidity in the weekly main refinancing operations. Until this date, the Nationalbank would adjust the lending rate when the ECB changed the refi rate, cf. Chart B. The ECB now stipulates a minimum bid rate, while the counterparties submit combined bids for liquidity and interest. The bids at the highest interest rate are allocated first and the ECB then accepts successively lower interest rates until the allocated amount is exhausted. The marginal rate is the minimum bid rate at which liquidity is allocated. The Nationalbank's lending rate will normally follow the marginal rate. As a result of the ECB's adjustment of its tender procedure the Nationalbank's situation changed. Since then, several technical adjustments of the lending rate have been required in order to maintain a suitable interest-rate differential to the euro area, cf. Chart C.

The Nationalbank's discount rate and the ECB's interest-rate corridor Chart A

Image: The Nationalbank's discount rate and the ECB's interest-rate corridor Chart A

The Nationalbank's lending rate and rates of interest in the ECB's main refinancing operations Chart B and C

Image: The Nationalbank's lending rate and rates of interest in the ECB's main refinancing operations Chart B

Image: The Nationalbank's lending rate and rates of interest in the ECB's main refinancing operations Chart C

A number of Danish banks raised their published interest rates by 0.5 percentage point after the adjustment of the discount rate on 6 October, although not all banks raised their deposit rates. The interest rates generally remained unchanged when the discount rate was raised in August.

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	Version 1.0 December 2000 Nationalbanken. Published by Danmarks Nationalbank December 2000, http://www.nationalbanken.dk