Monday, October 27, 2008

Fed Expected to Cut Rates; IMF to Give Ukraine Loan With Conditions

The U.S. Federal Reserve is expected to cut lending rates at a two-day policy meeting this week in response to unprecedented turmoil in financial markets.

The consensus among Fed watchers is for a half-point cut in overnight rates to 1%, which would be the lowest level since June 2004. The central bank is also expected to signal a willingness to lower borrowing costs again if needed -- especially with inflation pressures fading fast.

"The economic and financial stability backdrop could not be more challenging," said Robert DiClemente, chief U.S. economist at Citigroup. "The deteriorating economic outlook suggests still greater scope for action."

Fed Chairman Ben Bernanke and his colleagues, who gather on Tuesday and Wednesday, have already cut the benchmark federal funds rate to 1.5% from 5.25% over the past 13 months. They will announce their latest decision around 2:15 p.m. EDT on Wednesday.

The Fed held rates steady at its last policy meeting on September 16, but cut rates by a half-point on October 8 in an emergency move coordinated with other major central banks. The sharp rate cut was complemented by other recent steps to create new funding facilities or expand existing ones to try to ease strains in credit markets that had become increasingly paralyzed by risk aversion, especially after investment bank Lehman Brothers failed in September.

The coordinated efforts have helped ease the global credit crunch, but baby steps on short-term money markets have been overwhelmed by bigger problems for the overall economy.

"The stabilization of the financial system, though an essential first step, will not quickly eliminate the challenges still faced by the broader economy," Bernanke acknowledged in congressional testimony last Monday.

A Reuters poll on October 16 showed economists predicting the U.S. economy would contract for three straight quarters, beginning with the third quarter that ended last month. Such a streak of declining gross domestic product would be the longest since 1974-75.

The U.S. Commerce Department will release its first snapshot of third-quarter GDP on Thursday, the day after the Fed announces its decision.

The U.S. labor market has shed jobs for nine consecutive months, while industrial output slowed in September and consumer confidence has faltered, taking retail demand down.

The Institute for Supply Management's (ISM) index of factory activity fell in September to 43.5, into territory associated with recession, and regional indexes have suggested manufacturing activity has fallen further this month.

While retail sales dropped by 1.2% in September, a dramatic plunge in gasoline prices might salvage consumer spending in the final weeks of 2008 -- which would offer a bright spot for the economy.

Gas prices have already been tracking the sharp drop in the price of crude oil, which has fallen by more than half since a record peak at $147 in July. "If gasoline prices continue to move lower, they will start to act like an economic tail wind, which is clearly a positive development," said economists at Deutsche Bank.

San Francisco Federal Reserve Bank President Janet Yellen said on October 14 that the nation "appears to be in recession," while Chicago Fed President Charles Evans three days later said that the spike in the jobless rate to 6.1 percent from a low of 4.4 percent in March 2007 basically makes recession inevitable.

With the Fed's interest-rate ammunition already running low, Bernanke went before Congress last week and endorsed the idea of a second fiscal stimulus plan to complement the central bank's efforts to rescue the economy.

"With the economy likely to be weak for several quarters, and with the risk of a protracted slowdown, consideration of a fiscal package by the Congress at this juncture seems appropriate," Bernanke said.

The Fed had astounded some analysts in September by expressing equal worries about growth and inflation, even though energy and other commodities prices were already two months off their peaks and falling rapidly.

Since then the pendulum has swung further toward deflation, so September's assessment that "downside risks to growth and the upside risks to inflation are both of significant concern" will certainly be reworked.

Ten-year inflation expectations reflected in securities prices are now below 1 percent, or under the low end of a range that many policy-makers see as "price stability."

IMF to Give Ukraine $16.5 Billion Loan With Conditions

The International Monetary Fund (IMF) and Ukraine said on Sunday they had reached an agreement in principle for a $16.5 billion loan package to ease the effects of the global financial crisis.

But analysts said politicians would have to set aside differences to adopt a set of financial measures needed to clinch the deal and secure the loan. The former Soviet republic is in the throes of the latest bout of political turmoil that has gripped it since the 2004 "Orange Revolution."

With Ukraine facing its third parliamentary election in as many years, the hryvnia currency has slumped to a record low. Analysts are concerned over the ability of the government, firms and banks to refinance with global lending at a standstill.

The economy is expected to slow dramatically as prices fall for steel, Ukraine's major export, and energy costs climb. Foreign investment is also expected to drop, compounding the pressure on the currency by a current account gap.

"The IMF is moving expeditiously to help Ukraine, and this programme is focused on the essential upfront measures needed to maintain confidence and economic and financial stability," IMF chief Dominique Strauss-Kahn said in a statement.

Analysts welcomed the deal and said the $16.5 billion to be made available over two years was adequate for now.

"In terms of the figure, it's on the higher side of what was mentioned by key politicians in Ukraine. However, this is not such a big fund that it will solve all the problems in one swoop," said Martin Blum, head of EEMEA Economics and Strategy at UniCredit bank.

Ukraine can use the funds to bolster the central bank's reserves -- which it is now spending to stop the currency from sliding further -- and to prop up the banking sector.

Analysts said they did not expect news of the IMF loan to help Ukraine's fledgling stock market which has fallen 60% since the start of September when investors rushed from emerging markets. Bonds may do better though, they said.

The IMF statement said nothing about the conditions it sought from Ukraine. But a joint central bank and finance ministry statement said the government would have to draw up a balanced budget and introduce measures to support banks. "These include legislative changes which must be adopted very soon by Ukraine's parliament," the statement said. Parliament, which has a long history of fractious behavior, has been in disarray for the past week.

President Viktor Yushchenko dissolved the chamber this month after the collapse of a coalition of groups led by him and his estranged ally and now rival, Prime Minister Yulia Tymoshenko. The premier opposes the election.

The president called a December election, but suspended his decree last week to enable parliament to sit and approve financial legislation that include the IMF's demands.

But the prime minister's supporters blocked proceedings to prevent passage of any measures to finance the December poll. It is not certain now when it will take place. Parliament is next due to meet on Tuesday.

Competing packages of financial measures have been drawn up and it is not clear if either of them meet the IMF's conditions.

One package submitted to parliament failed to balance this year's budget. It extended sovereign guarantees to companies borrowing abroad, set out plans for government's own borrowing and barred troubled banks to pay out dividends.

"Judging by the (loan) figure, this is definitely something that allows the recapitalization of the banking system," said Katya Malofeeva, chief economist at Renaissance Capital. "This requires quite a bit of preparatory work and the bills submitted last week definitely didn't include that much detail."

She said two to three weeks would probably be required to approve the measures and passage was made more complicated by the unpredictable behavior of Ukrainian politicians. - Sounds quite a bit like our Congress.

Sources: Reuters, Yahoo

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