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The Bank of Japan finally ended its Zero Interest Rate Policy on Friday – ‘a further signal that the global era of cheap money is over’ as The Sunday Times put it.
The key interest rate rose to 0.25%, the first rise in six years.
The move was entirely expected, and somewhat eclipsed by the escalating carnage in the Middle East. And many believe it will be the Bank’s last hike this year.
But the markets may well be underestimating just how far and how fast Japanese interest rates will rise…
The statement accompanying the Bank of Japan’s decision to raise interest rates was taken to suggest that further rises will be a long time coming. The BoJ said that “an accommodative monetary environment ensuing from very low interest rates will probably be maintained for some time.”
But as Julian Jessop at Capital Economics points out, the US Federal Reserve used similar language when it started raising interest rates from the 1% level last seen in June 2004. The Fed has raised rates at every meeting since then. The key US rate now sits at 5.25%, and there may well be another hike next month.
Japan’s central bank is unlikely to raise rates at quite the same pace as the Fed. Mr Jessop reckons that there will be another rate rise in the last quarter of 2006, “followed by two or three increases during 2007.” However, he adds, “the economic backdrop suggests that the risks clearly lie on the upside.”
Wages are rising, while the latest Tankan business confidence survey showed that companies intend to hire more staff in the coming months. And as CE also point out, the markets are paying too much attention to “dovish comments from Ministry of Finance officials”.
Japan: how to profit from the land of the rising sun
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As is the case with governments across the world, Japan’s politicians have attention spans that stretch no further than the next election. And that means they aren’t terribly keen to see interest rates rising.
While higher rates are a welcome sign that Japan’s comeback is for real, the fear is always that the central bank will tighten too far – or rather, far enough to cause the voters some pain.
But as Mr Jessop points out, it’s not up to the politicians to set rates. Capital Economics reckon that rates could eventually go to at least 3%.
As Japanese rates catch up with the US, that will put even more pressure on the frail dollar. Small wonder that markets are starting to get excited about gold again, after May’s brief but nasty correction. Gold fell from $730 an ounce to as low as $544 an ounce, but is now back at around the $670 level.
Swiss bank UBS says that there has been a “surge in demand for gold options cashable at over $1,000 an ounce”. Traders are buying options, expiring in December, that would allow them to buy gold at $1,000. A few are even buying up options for late 2007 with a strike price of $2,500.
The options themselves are inexpensive – at the end of last week an option to buy gold at $1,000 before December was trading at around $3.60, says The Telegraph. So if the gold price goes to, say, $1,100 an ounce before December, a trader can make many times their original stake.
And of course, as the gold price rises, the option itself becomes ever more valuable, so selling the option on is another way to make a decent profit without ever actually buying any gold.
Of course, mainstream commentators can still hardly bring themselves to believe that boring old gold has become such an exciting profit-making opportunity. After all, in today’s glorious era of all-powerful central banks, why would anyone feel the need to buy into this ‘barbarous relic’, as John Maynard Keynes described it?
“It is hard to pinpoint why so many wealthy investors have become gold-bugs,” says the ever-reliable Ambrose Pritchard-Evans in The Telegraph, “but fears of a dollar slide are a key part of the picture.
“The concern is that the US Federal Reserve will ultimately opt for easy money rather than dispensing bitter medicine to purge excesses of debt and overspending.”
Mr Pritchard-Evans has put his finger on it. The Fed can keep raising interest rates, but that would almost certainly mean knocking over the already teetering US housing market.
The alternative is to cut rates at the first sign of recession, which would hammer the dollar, but be less uncomfortable (and less unpopular with the voters) than falling house prices – at least, in the short term.
Of course, cutting interest rates will in the long-term lead to even more far-reaching inflation than we have already seen. Last week we published a piece from Dr Marc Faber on why he believes the Fed and other central banks will eventually give in to the temptation to print more money. If you missed it, you can read it here: Why an inflationary bust is inevitable.
And as more and more investors (and more and more central banks for that matter) understand, there’s one asset you really want to be holding onto when inflation takes hold.
You can read more about why you should be investing in gold by visiting the gold and precious metals section of our website, here: Investing in gold
Turning to the wider markets…
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The FTSE 100 fell again amid soaring oil prices and concerns over the Middle East situation. The blue-chip index fell 57 points to 5,707. Broadcaster ITV was the main faller, down 4% to 96.25p on reports that advertising bookings for September are down 12% on last year. For a full market report, see: London market close.
The markets also fell sharply in continental Europe, with the Paris Cac-40 falling 71 points to close at 4,780. The German Dax-30 was down 105 points at 5,504.
Across the Atlantic, US stocks plunged again, as weak retail sales data raised fears that a slowdown is taking hold in the world’s largest economy. The Dow Jones Industrial Average lost over 100 points for the third session in a row, falling 106 to 10,739. The US benchmark index has now lost nearly 400 points in just three sessions. The S&P 500 closed 6 points lower at 1,236, while the tech-heavy Nasdaq dropped 16 to 2,037, its lowest close since May 2005.
The Wall Street sell-off hung over Asian and Australasian markets. Japanese and South Korean markets were shut for a holiday. Australia’s S&P/ASX 200 index shed 9 points to 4,956 on concerns that the Reserve Bank of Australia will raise interest rates again next month. And New Zealand’s NZX 50 index fell 0.8% to 3,590 on news that inflation rose to an annual rate of 4% in the second quarter. The key interest rate is already sitting at 7.25%, but may now go higher.
Oil remained high in New York this morning, with crude trading at around $77.50 a barrel. Brent crude was little changed, at around $76.05.
Meanwhile, spot gold hit a near-two-month high of $674 an ounce as investors piled in despite a firming dollar. Silver was also higher, trading at around $11.65 an ounce.
And in the UK this morning, housebuilder McCarthy & Stone has agreed a £1bn takeover from private equity group Permira and Barclays Capital. Shareholders will receive £10 a share. Shares closed at 942p on Friday.
And our two recommended articles for today…
How rising interest rates will boost gold
– As investors wait on the next round of central bank rate decisions, it looks as though the currencies story is about to get a lot more interesting. One thing’s for certain, though – there’s likely to be a happy ending for gold. To find out why Japanese and European interest rate hikes will be good for gold, see: How rising interest rates will boost gold
Two energy stocks to invest in now
– Although the price of natural gas is low relative to that of oil, this can only encourage the substitution of gas for oil. And as we enter the hurricane season, any disruption of the oil supply will lead to another price spike. So where should you invest? Gazprom is certainly the giant in this field, but do the benefits outweigh the much-publicised risks? Alternatively, you could look at the fast-growing area of coal-based methane technology. To find out what CBM is – and how to invest in it – read: Two energy stocks to invest in now