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17 Dec 2008

Financial Markets

Fed Signals End of Interest Rate Easing, But Liquidity Injections to Continue (Business Brief No.2379)

In the FOMC meeting held on December 15-16, 2008, the US Federal Reserve (Fed) surprised the market again by slashing their Fed Funds rate by more-than-expected 0.75-1.00 percent to a target range of 0.00-0.25 percent, from 1.00 percent previously. The post-meeting statement showed that Fed had given priority to increasing risks to growth, especially their deteriorating job market along with other weakening economic indicators including consumer spending, business investment and industrial production, as experienced since the last FOMC meeting. The Fed also stated that all available tools would be employed to support the resumption of sustainable economic growth and maintain price stability. In particular, Fed anticipates that the prevailing economic fragility will likely warrant an exceptionally low US policy rate for the foreseeable future.
The statement also showed that Fed would continue to focus on the support of the functioning of financial markets and stimulate the economy through open market operations (OMO), i.e., liquidity injection via the purchase of financial instruments (mostly issued by federal agencies) from financial institutions. As previously announced, over the next few quarters, the Fed will purchase large quantities of agency debts and mortgage-backed securities to provide support to the mortgage and housing markets, and stands ready to expand the purchases of such securities as conditions warrant it.
The Fed is now evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Fed will implement a Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. They reiterated their commitment to continuing the consideration of using their balance sheet to further support credit markets and economic activity.
KASIKORN RESEARCH CENTER (KResearch) holds the view that the key point seen in the post-meeting statement was that the Fed has signaled that easing monetary policy is coming to an end with the lower end of the Fed Funds rate target being set at 0.00 percent. The Fed is thus the first central bank among the G-7 nations that has cut the policy rate to zero. However, they are signaling that they will continue to use other forms of monetary policy (such as quantitative easing) to pacify strained financial markets and support economic growth. In so doing, bond yields, spreads and borrowing costs for households and small businesses (especially in the very tight credit market) will be driven downward somewhat.
For Thailand, the Bank of Thailand's Monetary Policy Committee (MPC) resolved to cut the 1-day R/P rate by one percentage point to 2.75 percent in their meeting held on December 3, 2008. In KResearch's view, the MPC will still be compelled to make further rate cuts later to ensure that an easing monetary condition takes hold in the Thai economy now threatened by numerous risks. Amid domestic political uncertainty that has severely hurt business sentiment and spending, global economic weakness and the possibility of a strengthening Baht – that reflects the wider spread between the Thai policy rate and its US counterpart - may become serious challenges for Thai exports, which will be indirectly affected by the BoT's interest rate policy, going forward.

KResearch forecasts that the MPC will likely cut their policy rate at least one percent more within 1H09. By that time, the inflation rate may fall close to zero or even be in negative territory during some months of 2Q09. Meanwhile, the Thai economy may enter a severe downturn from 4Q08 onwards. Our preliminary projection shows that the Thai economy in 4Q08 may encounter negative Q-o-Q growth. Overall, Thailand's economy may fall short of the forecast 1.00 percent growth in 1H09, influenced chiefly by domestic political uncertainty in addition to other external threats beyond our control.

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