Migrating to a new site

Hi all,

I've currently migrating to a new site. Check this out:
http://economics-zone.blogspot.com/

Investing tricks of the wealthy

Average investors can apply the same techniques to their own investments, no matter the size of their portfolio

Dec 19, 2007
By BEN FOK

RECENTLY, I asked a wealth manager whether an average investor can make more money by mimicking the investment strategies of the rich. He answered: not really. Later he explained that the rich invest differently because, well, they're different. They can take more risks because they have more money to lose. Furthermore, they can speculate and have a short-term view because losing money is not a problem for them.

Well, I do not totally agree with his opinion. For the past few years, I have been advising wealthy people on their financial well-being. As a financial adviser, my job is to help these rich clients search for financial services who meet their needs. Throughout my interaction with them, I have gained an insight into how they accumulate wealth.

I can tell that the rich don't necessarily have any special insights into which stocks or assets are going to soar. But what they do have is the confidence to apply a disciplined and systematic approach to managing their money. They have the habit of applying common sense to each investment opportunity facing them. Even though the interests of wealthy investors are not always necessarily aligned with those of the average investor, there are a number of principles and strategies employed by wealthy investors that do apply to virtually anyone who seeks to invest for the future.

It is a common fact that most financial textbooks teach us that in order to build wealth we need diversification, wealth preservation and strategic growth. To me, this not an accurate statement in itself because two of those strategies - diversification and preservation - don't help to build wealth. Perhaps the rich use these two strategies to maintain wealth.

After they have accumulated great wealth, they didn't use the strategies during the accumulation phase and they tend to preserve the wealth they have built. Yet average investors have not yet reached the ranks of the financially independent, so they are generally more concerned about investment growth and losses. The wealthy, as a general rule, do not have this concern. At the same time, they also learn how to avoid taxes legally so that they can keep their money working for them and learn how to pass their assets on to the future generations without the government taking a huge part of what they spent their lives building.

Another common perception is that the rich take more risk, therefore they accumulate wealth faster. However, the truth is that the majority of rich people do not build their fortunes by speculating on high-risk investments as is commonly believed. My experience tells me that the rich do not heavily rely on high-risk investment vehicles like hedge funds or venture capital funds but are moderate risk takers who put more than half of their money into listed securities and keep a large amount as cash. The reason for this is that they have so much money that even if they do not meet their goals for investment growth, it would not be bad news to them; however losing their financial independence would be devastating.

So how do the rich invest? Unlike the average investor, the rich think long term in most of their investment strategies. They believe that there is power in long-term thinking and many of them make it habit of doing so. Great investors like Warren Buffett - his successes in investment include Washington Post Co, where Berkshire invested US$11 million in 1973 and which investment was worth US$1.3 billion at the end of 2006. That is 33 years of holding power which demonstrates his investment philosophy - always invest for the long term. Hence, most rich do not engage in short-term speculation but have a long-term goal in mind.

However, the rich make use of risk by taking advantage of risk. They often build fortunes using volatile assets and investments but that does not mean they were engaging in risky behaviour. They understand the risk and embrace risk because they know it always brings an opportunity for growth; however, the average investor is fearful of risk. Nevertheless, taking risk for the rich does not mean taking a shot in the dark. The rich take calculated risk that means to gain knowledge first and to consider the consequences of failing before taking action. The rich overcome fear with knowledge as knowledge can cause fear to fade away.

The rich also demand value for their money. Otherwise, how do you think they got to be rich in the first place? Value to them is buying assets at a discount to its intrinsic value. So for them the right time to buy is when there is weakness in the market. They buy when others are despondently selling and sell when others are greedily buying. This requires the greatest fortitude but also has the greatest rewards. This bargain-hunting approach to buying value will enable them to buy quality assets at reasonable prices. So they buy when there is bad news and sell on good news. For instance, some of the wealthy invest because they understand that the weakness is only temporary, and the stock price had fully priced in negative news and it was time for them to hunt for bargains again.

If we look back at the Singapore stock market, there are many opportunities for investors to bargain hunt and buy on bad news, e.g. the Asian financial crisis in 1997/98, the Sept 11 terrorist attack and SARS. The rich take advantage of these negative events to buy assets, whether in real estate or stocks and that's where value can be found. However, the average investor will seek to sell and get out of a bear market fearing that the asset will fall in value.

To the rich, probably now is the best time to sell and get out of the market, where all assets prices have gone up in value. Over the past years, we have very good reports about our economic growth and all the good news are now factored into the stock price, so for the rich it's time to sell.

Another investing secret of the rich is that they approach investing like a business. They set up a business plan, establish annual targets, then analyse the results and they have reasonable expectation. At the end of the day what they want to achieve is increasing their net worth and not their income. The rich truly understand the meaning of working smart not working hard: to focus on growing your net worth is working smart but working for an income is working hard. As their net worth grows, they do not increase their spending, instead they increase their investment. By repeating this over the years, once their net worth is built to a certain level, they are free to do what they want. Hence, to increase your net worth you need patience, knowledge, and wisdom.

Often they are not willing to pay more for investment services simply because they find a particular adviser to be charming or knowledgeable. Nor do they chase after the hottest manager or the most publicised fund. Instead, they go shopping for the best combination of reasonable fees and consistently good performance. However, they will pay for advice from people who have specialised knowledge in a field they need to learn about. They don't believe in free advice as it can often be the most expensive advice.

As you can see, most investing secrets of the rich are nothing more than a combination of basic common sense and knowledge. The difference between the rich and the average investor is that they have the self-confidence to stick to the basics and to find out what they need to know. They don't get caught up in the theory of the week or the trend of the month. It's an approach that's easy to articulate but difficult to follow.

However, average investors can learn important lessons from the wealthy, specifically the need to manage both risk and their own investment expectations. The failure to match expectations to the risk an investor is willing to take can result in frequent switching among investments, or even worse. Now the good news for the average investor is that you can apply many of the same techniques to your own investments, no matter how big or small your portfolio is.

Fed proposes mortgage rules to protect borrowers

Dec 19, 2007 - Lenders would have to confirm that a borrower can afford a mortgage before making the loan under protections proposed by the Federal Reserve on Tuesday following the havoc wrought by the US sub-prime loan crisis.

The proposals are intended to replace loose standards that have put many Americans at risk of losing their homes because they took out loans they could not afford and may not have fully understood.

The new rules will not assist today's struggling homeowners but would give consumers the right to sue mortgage lenders who act unfairly and deceptively in preparing loans. Millions of Americans who stretched to buy homes in recent years face the risk of foreclosure as mortgages with initial 'starter' rates reset sharply higher.

The Fed's board of governors unanimously approved the standards recommeded by its consumer rights staff and said they strike a balance by protecting consumers while preserving their access to credit.

'These new rules, once adopted, would apply to all mortgage lenders,' Fed Chairman Ben Bernanke said as the board met to consider the proposal. He said the rules would be 'consistently applied and vigorously enforced' by state and federal regulators.

The new rules would put the nation's 50,000 mortgage brokers under some federal supervision, according to Fed staff.

The proposal was criticised by several leading lawmakers and praised by an industry group.

The Fed has been faulted for failing to use all its consumer protection authority during the housing boom that ended in 2005, and lawmakers are threatening to take back some of those powers.

The proposed regulations would require that lenders confirm a borrower can afford a home loan by verifying his income and assets with tax records, payroll receipts and other documentation. That is aimed at ending the recent practice of so-called 'stated income' loans in which borrowers could state a particular income without anything to back the claim up.

The proposals would also limit the penalties imposed when a borrower pays off a home loan early. No 'prepayment penalty' would apply, for instance, if a loan is refinanced less than 60 days before its interest rate resets higher.

The proposed rules also would require that borrowers receive details on their brokers' compensation and be billed monthly for annual charges, such as property tax and insurance, that are placed in escrow.

The Fed plan also contains sweeping new standards for home appraisers and targets abusive practices by loan servicers.

The proposed regulations protect borrowers with interest rates of more than 3 percentage points above Treasury securities of similar duration. For example, a 30-year Treasury bond yields around 4.55 percent, and so a 'high-cost' 30-year mortgage loan today would have an interest rate of 7.55 per cent or higher.

Several leading lawmakers said the new rules were too little, too late and suggested Congress should assume some of the Fed's consumer protection role.

Senate Banking Committee Chairman Christopher Dodd faulted the Fed for limiting mandatory escrow to the mortgage's first year and opening only a two-month window of prepayment protection.

'It raises serious questions as to whether the Federal Reserve is the appropriate institution to house consumer protection functions,' the Connecticut Democrat said.

Mr Dodd, a Democratic presidential hopeful who has sponsored legislation aimed at reforming sub-prime mortgage lending, said legislative action was needed to help protect homeowners from 'abusive and predatory lending practices'. The Senate has yet to act on his legislation, but the House of Representatives has passed a bill aimed at curbing predatory lending practices.

The American Bankers Association praised the Fed for setting standards that could reach mortgage lenders who used Wall Street money to dive into the market and generally loosened standards more than depositor-backed institutions.

The proposed regulations will be open to public comment for 90 days before the Fed staff proposes final rules. At that point, there will be another public comment period, pushing final adoption well into next year.

HK's central bank cuts base rate by 25 basis points

Dec 12, 2007 - The Hong Kong Monetary Authority (HKMA) on Wednesday lowered the base rate charged through its overnight discount window by 25 basis points to 5.75 per cent.

The HKMA's move came after the U.S. Federal Reserve cut benchmark interest rates by a quarter-percentage point to 4.25 per cent to prevent economic fallout from credit turmoil stemming from troubles in the U.S. mortgage market.

Hong Kong tends to track US rate moves because its currency is pegged to the US dollar.

The HKMA, Hong Kong's central bank, sets its base rate through a formula that includes the US federal funds rate and Hong Kong interbank offered rates.

Fed Lowers Rate by a Quarter Point to 4.25 Percent

Dec. 11 (Bloomberg) -- The Federal Reserve lowered its benchmark interest rate by a quarter point to 4.25 percent, while signaling officials are open to further cuts if the housing slump and credit squeeze worsen.

Stocks fell and Treasury notes surged after the decision, which some economists said fell short of what's needed to spur lending and avert a recession. The central bank also pared the discount rate by a quarter point to 4.75 percent, counter to speculation among investors that the Fed would make a deeper reduction.

``Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation,'' the Federal Open Market Committee said in a statement after meeting today in Washington. Lower borrowing costs ```should help promote moderate growth over time.''

The Fed dropped language from its previous statement that risks of slower growth and faster inflation were ``roughly'' balanced. The economy is faltering after a third-quarter surge as house prices drop, consumer spending slows and banks tighten lending standards for even their best customers.

Policy makers are actively considering steps to ease credit in financial markets, and haven't ruled out moves to increase liquidity before their next scheduled meeting on Jan. 29-30.

``If things deteriorate they will cut again,'' said Stephen Cecchetti, professor of international economics at Brandeis University in Waltham, Massachusetts, and a former director of research at the New York Fed. ``If financial conditions don't start to improve dramatically,'' officials might have to cut before their January gathering, he said.

Discount Rate

The gap between the discount rate, which the Fed charges for direct loans, and the federal funds rate, the rate banks charge each other for overnight loans, remains half a point.

``Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending,'' the FOMC said. ``The committee will continue to assess the effects of financial and other developments in economic prospects and will act as needed to foster price stability and sustainable economic growth.''

The central bank also said some ``inflation risks remain,'' and probably was reluctant to reduce borrowing costs at all, said Vincent Reinhart, former director of the Fed's Division of Monetary Affairs and now a resident scholar at the American Enterprise Institute in Washington.

Rosengren Rebels

Today's decision, which matches the median forecast of economists surveyed by Bloomberg News, wasn't unanimous. Boston Fed President Eric Rosengren voted in favor of a half point cut.

Rosengren has a background in banking, having formerly headed the Boston Fed's banking supervision department. His research focused on financial crises including New England's credit crunch in the early 1990s and Japan's bad-loan debacle last decade.

The Dow Jones Industrial Average slumped 2.1 percent to 13,432.77, while the yield on the two-year Treasury note -- among securities most sensitive to official interest rates -- fell about a quarter-percentage point to 2.92 percent at the close in New York.

``When stocks go into a tailspin after you release your press statement, you know as a central banker that you didn't meet the market's expectations,'' said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. ``There were rumors today about the possibility of 50 basis points, so that was a modest disappointment.''

Policy Under Bernanke

The benchmark rate is now at the lowest level since January 2006. Ben S. Bernanke, 53, who succeeded Alan Greenspan as chairman the following month, continued a series of increases that lifted the federal funds rate to 5.25 percent by June last year.

Policy makers held their ground until August this year, when the collapse in assets backed by subprime mortgages roiled markets around the world and forced central banks to pump billions of dollars into the banking system. It also spurred the Fed to start cutting the federal funds rate in September. The Fed was joined last week by the Bank of Canada and Bank of England.

Investors became confident of further reductions after Bernanke and Vice Chairman Donald Kohn said in separate speeches last month that ``turbulence'' in markets could alter their outlook for growth. Fed officials estimated in October the economy would grow 1.8 percent to 2.5 percent in 2008. Rosengren said Dec. 3 that the expansion will be ``well below'' its long- term pace for the next two quarters.

Weaker Numbers

Since Fed officials made their forecasts, government reports show orders for U.S.-made durable goods fell in October, capacity-use rates in the nation's factories slipped and retail sales slowed. Payrolls increased by 94,000 jobs last month, after a 170,000 increase in October.

The economy will expand at an annual pace of 1 percent in the fourth quarter, down from 4.9 percent in the previous three months, according to the median estimate in a Bloomberg News survey of 63 economists.

The number of Americans who fell behind on their mortgage payments rose to a seasonally adjusted 5.6 percent in the third quarter, the highest in two decades, the Mortgage Bankers Association said last week. New foreclosures hit a record.

As creditors took possession of properties, the supply of unsold homes grew to a 10.8-month supply in October. Prices of previously owned homes fell 5.1 percent from a year ago, the most on record, according to the National Association of Realtors.

Across Atlantic

The credit deterioration has spread to Wall Street and commercial banks around the world that hold bonds and derivative contracts created from pools of home loans. Banks including Credit Suisse Group in Zurich and London-based Barclays Plc are among lenders that have marked down more than $50 billion on losses linked to U.S. home loans.

Because banks are protecting capital, lending has been cut and concerns about counter-party risk are higher. About 40 percent of lenders have increased their standards for the most creditworthy borrowers to qualify for a so-called prime loan, according to a Fed study in October.

Throughout the rate cutting-cycle, Fed officials have highlighted longer-term inflation risks in their statements and their public remarks. Oil prices hit a record $99.29 a barrel in New York on Nov. 21, and traded at $89.21 this morning.

The Fed's preferred gauge, the personal consumption expenditures price index excluding food and energy, rose 1.9 percent in October from a year ago. The index has remained below 2 percent since June.

Not all bonus issues are good news

BONUS share issues are usually viewed positively. Investors welcome them and companies always present such issues as efforts to reward shareholders. And there have been no shortage of bonus issues on the Singapore Exchange (SGX) in recent months. At least a dozen or so SGX-listed companies have announced bonus issues, according to filings with the stock exchange.

However, like most things, bonus issues aren't always all that they are made out to be.

A bonus issue refers to the issue of new shares to existing shareholders at no cost and in direct proportion to their existing shareholdings in the company. So in a 1-for-4 bonus issue, for instance, shareholders get one new share for every four existing shares they hold.

Because bonus issues are free, it is well understood that they do not directly benefit the company. This is unlike rights issues (where shareholders pay for rights shares at a discount to the market price) which raise funds for the company. Bonus issues also do not materially alter the balance sheet of a company. They are normally done using the retained earnings of a company and involve a book entry transferring an amount from retained profits to share capital. This is also known as the capitalisation of reserves.

But do bonus issues really benefit shareholders, as companies make them out to be?

This is debatable. It can be argued that, theoretically, a bonus issue brings no additional benefit to the shareholder.

While it is true that the shareholder would end up with more shares at no cost, the share price would - theoretically at least - also adjust downwards accordingly to what the market calls the theoretical ex-price. Issuing bonus shares also has the effect of diluting earnings per share.

One way shareholders would benefit from a bonus issue is when the adjusted lower share price makes the stock more affordable and encourages more investors to invest in it. This would result in more liquidity and potentially more upside for the share price.

This would be what companies want shareholders to believe, and indeed, is the rationale given in every bonus issue announcement. Such an outcome is not a given, however, and the share price performance depends not just on having more shares in issue but on a host of other factors.

There are, in fact, some hidden dangers in bonus issues.

For one, companies may be making bonus issues in lieu of dividends. So while getting more shares at no cost, shareholders may be forgoing cash dividends. In some cases, like when a company needs to conserve cash to expand its business, there are sound reasons for a bonus issue in lieu of dividends. But this does not apply to all situations, and shareholders should ask if a bonus issue is masking the lack of dividends when these should be forthcoming.

Another danger is when a penny stock makes a bonus issue. While there may be a good reason for a high-priced stock to make a bonus issue to improve affordability and boost liquidity, it's harder to apply this logic to penny stocks which are already affordable in the first place. So if a penny stock becomes even cheaper, it may pull in speculators rather than long-term investors. Indeed, institutional shareholders - which companies value - are known to shun very low-priced stocks. Attracting speculators and the syndicates may boost the share price in the short term, but if this comes at the expense of having serious investors as stakeholders, it could ultimately curb the upside potential of a stock in the long term.

The other thing to watch out for is when recently listed companies make bonus issues. Companies often say they are rewarding shareholders' loyalty when they make a bonus issue. For a newly listed company, however, there really is no shareholders' loyalty to speak of. So the motives a company has in making a bonus issue in such a situation should be questioned.

Of course, there are many bond fide bonus issues made by companies which are doing well, are confident of their future prospects and are genuinely seeking to reward shareholders. But investors should not see all bonus issues as good news. There may well be a sting at the end of the tail.

Weekly Indicators - Nov 1

Nov 1st 2007
From The Economist print edition

The Federal Reserve cut its target for the federal funds rate to 4.5%. One member of the Fed's rate-setting committee voted to keep rates unchanged at 4.75%.

Other central banks followed a different path. Sweden's Riksbank raised its benchmark interest rate by 0.25 percentage points to 4% and said further increases were likely. India's central bank left rates unchanged but raised the cash reserves that banks need to keep with it from 7% to 7.5% of total lending. Central banks in Japan, Norway, Hungary, Poland and Malaysia all kept their key interest rates unchanged.

America's GDP rose at an annualised rate of 3.9% in the third quarter, according to an initial estimate. The stronger-than-expected increase owed much to an improved trade performance, which almost offset the adverse effects on growth of falling housebuilding. The S&P/Case-Shiller house-price index that covers 20 large American cities fell by 4.4% in the year to August.

Consumer prices in Japan fell by 0.2% in the year to September. Prices excluding fresh food fell by 0.1% from a year earlier. The unemployment rate rose from 3.8% to 4%.

Consumer prices in the euro area rose by 2.6% in the year to October, according to a preliminary estimate, compared with 2.1% in the year to August. The unemployment rate fell to 7.3%. The figure for August was revised from 6.9% to 7.4%, owing to changes to the way Germany's jobless are counted.

Fed Lowers Rate by a Quarter Point to 4.5 Percent

Oct 31, 2007 - The Federal Reserve cut its benchmark interest rate by a quarter point to 4.5 percent and signaled it's reluctant to lower borrowing costs further.

The second reduction in as many months should help the U.S. economy withstand the fallout from August's credit collapse, the Federal Open Market Committee said in a statement after meeting today in Washington. ``After this action, the upside risks to inflation roughly balance the downside risks to growth.''

The language ``has all the subtlety of a sledgehammer,'' said Stephen Stanley, chief economist at RBS Greenwich Capital in Greenwich, Connecticut. ``The FOMC has just stated unequivocally that `we think we are done easing.' Whether they are or not remains to be seen, but the message is loud and clear.''

Hours earlier, the Commerce Department said economic growth accelerated to an annual pace of 3.9 percent in the third quarter, the fastest in more than a year. The Fed statement also warned that higher energy and commodity prices may spur faster inflation.

Stocks fell in the minutes after the Fed announcement, before resuming their rally. Treasury notes declined and the dollar weakened.

The Fed acknowledged that ``economic growth was solid in the third quarter, and strains in financial markets have eased somewhat on balance.'' At the same time, ``the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction.''

Hoenig Dissents

Today's decision wasn't unanimous. Kansas City Fed President Thomas Hoenig preferred no change, the first dissent since December.

The Fed also lowered the discount rate, the cost of direct loans to banks, by 25 basis points to 5 percent, from 5.25 percent. A basis point is 0.01 percentage point.

``Unless the incoming data signal a net increase in downside growth risk, they think they are done,'' said Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, New York. ``Inflation worries -- oil and commodities -- just won't go away.''

Policy makers have now lowered their target rate for overnight loans between banks by 0.75 percentage point in six weeks, the most aggressive easing since the economy was emerging from its last recession in 2001.

Odds of a quarter-point cut in the benchmark rate at the Dec. 11 meeting receded to 40 percent, from 66 percent yesterday, according to futures contracts quoted on the Chicago Board of Trade.

Economists and former officials said before the meeting that the central bank would want to preserve leeway to take back the rate cuts should the economy weather the risks from credit and housing markets. Vice Chairman Donald Kohn said Oct. 5 the Fed must be ``nimble in adjusting policy to promote'' both growth and price stability.

Insurance

Chairman Ben S. Bernanke, 53, and other officials in speeches this month have described the importance of taking out insurance to protect the economy from risks when the outlook is difficult to judge.

``Intuition suggests that stronger action by the central bank may be warranted to prevent particularly costly outcomes,'' Bernanke said in an Oct. 19 speech on recent economic research. Chicago Fed President Charles Evans said Oct. 22 that ``at times we may need to adopt a risk management approach to policy'' to guard against threats to growth or inflation.

Consumer-price increases have slowed, while a falling dollar and rising oil costs threaten a renewed acceleration. The Fed's preferred gauge, the personal consumption expenditures price index excluding food and energy, probably rose 1.8 percent in September from a year ago, according to the median forecast. The Commerce Department reports the figures tomorrow.

The index remained below 2 percent from June to August. Bernanke, before taking the Fed's helm, said his ``comfort'' range for the measure was 1 percent to 2 percent.

Faster Expansion

The Commerce Department said today that the expansion picked up in the third quarter, though economists surveyed by Bloomberg predict a slowing this quarter. A private report showed companies hired 106,000 this month after creating 61,000 jobs in September.

The economy grew at a 3.9 percent annual rate in July to September, up from 3.8 percent in the previous three months, Commerce figures showed. It will slow to a 1.8 percent pace in the current period, according to the median estimate in a survey published Oct. 10.

Housing Downturn

Housing figures this month showed the industry has yet to find a bottom. A private survey yesterday showed home values in 20 metropolitan areas slid the most in at least six years. Sales of previously owned homes fell to the lowest level since National Association of Realtors began keeping records in 1999, and government figures recorded a 14-year low for housing starts.

Continued stress in credit markets may lengthen the housing recession and temper business investment plans. The world's largest banks and securities firms announced more than $30 billion of third-quarter charges.

Citigroup Inc. the biggest U.S. bank, said Oct. 15 that earnings fell 57 percent as loan losses increased. Merrill Lynch & Co. last week wrote down the value of subprime mortgages, asset-backed debt and leveraged loans by $8.4 billion.

The benchmark rate is now at the lowest level since January 2006. Bernanke took office the following month, and continued a series of rate increases that lifted the federal funds rate to 5.25 percent by June last year.

Mexico Central Bank Unexpectedly Raises Rate to 7.50%

Oct 26, 2007 - Mexico's central bank unexpectedly raised interest rates and said inflation will take longer to retreat than policy makers previously estimated.

The five-member board, led by Governor Guillermo Ortiz, lifted the benchmark rate a quarter percentage point to 7.50 percent, surprising 22 of 29 economists surveyed by Bloomberg. The peso climbed to a three-month high.

Inflation hasn't slowed as quickly as the central bank predicted in May, when it said the rate would fall to 3 percent by the end of next year. Today, the bank revised its outlook to estimate the target won't be reached until the end of 2009 because of rising food prices and higher taxes approved by Congress last month. It also dropped its ``restrictive bias,'' hinting it doesn't intend to follow with more increases.

``They had to show commitment to the target,'' said Alonso Cervera, a Latin America economist at Credit Suisse Group in New York, who predicted the increase correctly. ``It would have been very odd for them to increase their inflation forecast and then not come through with a rate hike.''

The economists who predicted today's increase, such as Cervera, Dresdner Kleinwort's Omar Borla and RBS Greenwich Capital Markets' Benito Berber, said they don't expect the bank to raise interest rates again this year. In today's statement, said the threat to Mexico's economic expansion from a decelerating U.S. economy had increased.

`Preventive'

``Clearly it was a preventive move,'' Borla said.

The decision marks the second time this year the central bank unexpectedly raised borrowing costs in Latin America's second-largest economy. The bank in April also unexpectedly increased its rate by a quarter percentage point.

Mexico's benchmark stock index rose 250.66, or 0.8 percent, to 32,123.6. The peso gained 0.7 percent to 10.7345 per dollar.

A report Oct. 24 showed core inflation rose more than expected in the first half of October because of higher prices for pasteurized milk and tobacco.

Core consumer prices, which exclude fresh food and energy, rose 0.21 percent, more than the median estimate of 0.15 percent in a Bloomberg survey of 18 economists, putting them at 3.87 percent on an annual basis, higher than the 3.5 percent forecast the central bank has for the end of the year.

Core Prices

That report led RBS Greenwich's Berber to change his forecast to predict central bankers would raise to 7.50 percent today. The central bank has missed its 2-to-4 percent inflation target in eight of the past 13 months.

Rising food prices may lead Mexico to suspend import duties on wheat for three months to reduce costs for local food producers, El Milenio newspaper reported Oct. 24, citing Economy Minister Eduardo Sojo.

Rate increases put the central bank at odds with President Felipe Calderon's administration.

Finance Minister Agustin Carstens criticized the bank in April for raising rates, saying it had acted ``prematurely'' at a time of slowing economic growth. In an Oct. 23 interview from Washington, Carstens said Mexico doesn't have an inflation problem and ``there are no underlying inflation pressures.''

Central bankers seemed to disagree with that assessment today in their statement, saying ``greater pressures on food prices and the probable impact of the recently-passed tax reform'' had led to their inflation-outlook change.

Fuel Tax

Congress last month passed tax legislation backed by Calderon that includes a 5.5 percent levy on gasoline that will take effect in January.

Meanwhile, Mexico's economy is expected to slow on falling demand from the U.S. According to the IMF's World Economic Outlook released Oct. 17, Mexico's economic growth will fall to 2.9 percent this year from 4.8 percent in 2007. Growth in 2008 is forecast at 3 percent.

Mexico sold a record $211.9 billion, or about 85 percent of its exports, to the U.S. last year.

Yields on Mexico's 10-year benchmark security have risen 28 basis points since the end of May on concern that U.S. growth will decline as subprime mortgage loan defaults push up borrowing costs.

Today's decision follows months of warnings from policy makers that they were prepared to raise rates should inflation not begin to decelerate fast enough to reach 3 percent by the end of 2008.

`End of the Line'

In May, the same month it introduced its 3 percent forecast, the bank adopted a ``restrictive bias,'' meaning it was more likely to raise rather than cut rates. In subsequent months, central bank surveys showed economists did not believe inflation would decelerate so rapidly.

Inflation will end 2008 at 3.69 percent, according to the average estimate of 33 economists surveyed by the bank between Sept. 24 and Sept. 28.

``In October the Bank of Mexico reached the end of the line,'' said Guillermo Aboumrad, an economist with Banco UBS Pactual in Mexico City, who forecast policy makers would increase borrowing costs today. ``Either they're meeting the inflation targets or they're not.''

U.K. Economy Grows Faster Than Forecast on Services in Q3

Oct 19, 2007 - The U.K. economy grew faster than economists forecast in the third quarter, driven by services from airlines to banks, a sign higher borrowing costs have yet to cool expansion.

Gross domestic product increased 0.8 percent, the same as in the second quarter, the Office for National Statistics said in London today. Economists forecast 0.7 percent, according to the median of 34 predictions in a Bloomberg News survey. The annual growth rate was 3.3 percent, the most since 2004.

Service industries, which make up three-quarters of the economy, expanded as business and finance held at the quickest growth pace since 2003. Investors speculate bank earnings will now weaken after credit costs jumped. Bank stocks comprise 37 percent of the benchmark FTSE-100 index, whose 6 percent gain this year has lagged increases of 11.4 percent on the Dow Jones Industrial Average and 20 percent for Germany's DAX.

``The momentum coming into the U.K. economy in the services sector, particularly in the financial sector, will abate,'' Kenneth Wattret, an economist at BNP Paribas in London, said in an interview. ``That will put Bank of England rate cuts on the agenda for early next year.''

The pound rose 0.4 percent after the report and traded at $2.0493 as of 12:31 p.m. in London. The currency reached a 26- year high of $2.0654 on July 24.

Rate Increases

The Bank of England raised its benchmark rate to 5.75 percent in the year through July, leaving Britons with the highest borrowing costs in the Group of Seven industrialized nations and increasing the repayments on the nation's record 1.4 trillion pounds ($2.8 trillion) of consumer debt.

London, which rivals New York in some markets as the world's largest financial center, has led the U.K.'s economic growth after a banking boom prompted record bonus payouts of 8.8 billion pounds at the start of this year, the Centre for Economics and Business Research Ltd. estimates.

Contagion from the U.S. mortgage market collapse, which prompted a surge in borrowing costs, is spreading to the U.K. and Europe. A worsening U.S. housing slump sent profits lower at Bank of America Corp. and Washington Mutual Inc. yesterday, putting financial company earnings on pace for the worst quarter in at least a decade.

Business Services

Business and financial services, which account for 28 percent of the U.K. economy, expanded 1.7 percent, the statistics office said. Manufacturing growth slowed to 0.2 percent from 0.8 percent in the second quarter.

The International Monetary Fund on Oct. 17 raised its forecast for the U.K. economy this year, predicting growth of 3.1 percent, the fastest pace since 2004. The fund forecast expansion to slow to 2.3 percent in 2008. The group predicts the euro-region's economy will grow 2.5 percent this year and 2.1 percent next year.

The IMF also reduced its global growth forecast for 2008 and warned that it might still be too optimistic, given threats posed by the sell-off in credit markets. The U.K. GDP report is the first for the third quarter from a G-7 economy.

Britain's growth will be among the fastest of the G-7 this year and the economy is well placed to weather a slowdown, Chancellor of the Exchequer Alistair Darling told lawmakers in Parliament yesterday. The Labour government, led by Tony Blair until Gordon Brown replaced him as prime minister in June, has now overseen 41 consecutive quarters of growth.

Northern Rock Panic

The collapse of the U.S. subprime mortgage market led to a jump in credit costs and a panic among savers at Northern Rock, the Newcastle-Upon-Tyne, England-based home-loan lender.

A survey of U.K. banks shows they are now poised to reduce the supply of credit to companies ``significantly,'' the Bank of England said Sept. 26. Services expansion weakened to a 13-month low in September, the Chartered Institute of Purchasing and Supply and Royal Bank of Scotland Group Plc said Oct. 3.

U.K. house prices fell at the fastest pace in two years in September after higher interest rates and concern about the outlook for economic growth sapped homebuyers' confidence, the Royal Institution of Chartered Surveyors said Oct. 11.

Bank of England Governor Mervyn King said in an Oct. 9 speech that policy makers won't reduce the benchmark interest rate to shield banks from the credit slump.

While the bank's Monetary Policy Committee considered a cut at its Oct. 4 meeting, only David Blanchflower sought an immediate move, citing ``downside'' risks to economic growth. The majority of policy makers said that business surveys have ``stayed firm'' and there is little sign of weakening.

Inflation stayed below the bank's 2 percent target for a third month in September, giving policy makers scope to reduce the benchmark if growth slows. Annual gains in consumer prices, at a rate of 1.8 percent, matched the lowest since March 2006.

Of 18 economists surveyed Oct. 12 by Bloomberg News, 12 predict the bank will lower its rate by a quarter-point in February. Four expect a reduction in November.

China Requires Banks to Set Aside Bigger Reserves

Oct 13, 2007 - China ordered banks to set aside more money as reserves for the eighth time this year to cool speculation in stocks and real estate and curb the fastest inflation in 10 years.

Lenders must park 13 percent of deposits as reserves from Oct. 25, up from 12.5 percent, the People's Bank of China said today on its Web site. The required ratio is the highest in almost a decade.

Seven increases in the reserve requirement and five interest-rate rises this year probably failed to stop the economy expanding faster than 11 percent for a third quarter, a government report may show next week. Surging exports have pumped money into the world's fastest-growing major economy, fanning inflation and fueling a boom in shares and real estate.

"They're clearly concerned primarily about inflation, because it did get out of hand over the summer," said Dariusz Kowalczyk, chief investment strategist at CFC Seymour Ltd. in Hong Kong. Inflation 'creates asset bubbles because when inflation is high then it doesn't seem meaningful for people to save money -- they would rather invest in real estate or the stock market.'

China's consumer prices surged 6.5 percent in August from a year earlier, the biggest jump since December 1996. The rate breached the government's annual 3 percent target for a fourth consecutive month, as food costs soared. Inflation was a factor in protests that led to the Tiananmen Square crackdown in 1989.

China's trade surplus jumped 56 percent in September, the customs bureau said yesterday, taking it to $185.65 billion for the first nine months of the year, more than the $177.5 billion for all of last year.

Money Supply

Money supply is surging because the government wants to hold down the yuan, forcing the central bank to sell the currency and pump cash into the banking system. Some of that money is finding its way into stocks, pushing the benchmark CSI 300 Index up 181 percent this year. Money supply rose 18.5 percent in September.

The economy, the world's fourth largest, probably grew 11.5 percent in the third quarter, the government may announce next week, according to the median estimate of 14 economists surveyed by Bloomberg News. The date for the release of the gross domestic product report hasn't been set.

Of 20,000 households surveyed in a central bank quarterly report released Sept. 20, a record 61.3 percent said they expect inflation to quicken in the fourth quarter.

Inflation Expectations

"Inflation is a priority for policy makers because in China, it is not just an economic problem, but also a political risk," said Chris Leung, senior economist at DBS Bank Ltd. in Hong Kong. "The Chinese government wants a `harmonious society,' but how can you have one with prices going up?"

Inflation is raising the risk of social unrest as the ruling Communist Party prepares for its 17th National Congress, a five-yearly meeting starting Oct. 15 that will decide leadership changes.

China has taken other action to combat rising prices.

All government-regulated prices have been frozen until the end of the year, and the state has boosted the supply of grains, vegetables and pigs and cracked down on illegal collusive price increases. The central bank has sold bills to soak up cash from the financial system.

Household Savings

Stock and house prices have gained as households shifted money from low-yielding bank deposits. Household savings fell 41.8 billion yuan in August from the previous month. Housing prices jumped 20.8 percent in Shenzhen and 12.1 percent in Beijing in August.

China has resisted calls from the U.S. and Europe to let its currency strengthen at a faster pace, which would make imports less expensive and ease pressure on domestic prices as well as helping to curb the widening trade surplus.

The yuan has gained about 10 percent to 7.51 versus the dollar since the end of a fixed exchange rate in July 2005.

"Unless the Chinese allow the exchange rate to go up, I'm worried about the stability of the economic system," former Federal Reserve Chairman Alan Greenspan said in a speech in London on Oct. 2. "The exchange rate will create more economic problems than they know."

The government will be forced into further reserve ratio increases soon, according to Kowalczyk of CFC Seymour Ltd.

"The impact will be negligible," he said. "When you look at how much in yuan terms is taken away from the money market, it's not enough to neutralize the impact of maintaining the exchange rate."

U.S. Economy: Retail Sales Ease Recession Concerns

Oct 12, 2007 - Retail sales in the U.S. blew past economists' forecasts last month, reducing concerns that a housing-fueled consumer slowdown might drag the economy into recession.

The 0.6 percent increase was double the previous month, the Commerce Department said today in Washington, and three times the size predicted by analysts in a Bloomberg News survey. Separately, the Labor Department said core producer prices, which exclude food and energy, rose less than anticipated.

The retail report spurred investors to pare bets that the Federal Reserve will continue cutting interest rates to keep the economy growing.

"The pessimism that's been so widely spread about collateral damage from housing hasn't been realized," said Richard DeKaser, chief economist at National City Corp. in Cleveland, Ohio. "The downside risks so feared a month ago have diminished."

Bonds recouped some of their losses after the Reuters/University of Michigan preliminary index of consumer sentiment fell to 82.0 from 83.4 in September. The gauge compares with an average 89.6 in the first half of the year.

"It matters more what consumers do than what they say," said Kevin Flanagan, a Purchase, New York-based fixed-income strategist at Morgan Stanley's Global Wealth Management Group. "The decline in confidence is not spilling over into a significant retrenchment in spending."

Purchases excluding automobiles rose 0.4 percent, compared with a decline of 0.4 percent in August.

Wholesale Prices

The 0.1 percent increase in core wholesale prices eased concern that rising fuel and food costs would filter through the economy. Overall prices increased 1.1 percent as oil costs climbed.

The yield on the benchmark 10-year Treasury was 4.68 percent at 4:54 p.m. in New York. Earlier, the yield increased as high as 4.69 percent in the minutes after the retail figures were released. The Dow Jones Industrial Average rose 78 points, or 0.56 percent, to close at 14,093.1.

Inventories at U.S. businesses rose a less-than-forecast 0.1 in August, a separate report from the Commerce Department also showed. Economists said companies are holding back on production and spending as they gauge the effect on demand from the deepening housing slump.

Today's retail sales report showed purchases at automobile dealerships and parts stores rose 1.2 percent after climbing 3.3 percent in August.

Electronics, Groceries

Sales at electronics and appliance stores rose 0.9 percent, and purchases at food and beverage merchants increased 0.8 percent. Americans also spent more to fill up their gasoline tanks. Filling station sales increased 2 percent in September after dropping 2.6 percent in August.

The report also reflected the effects of the decline in the housing market and the weakness reported yesterday in sales at chain stores. Furniture sales dropped 0.6 percent and building materials gained just 0.1 percent. Clothing weakened 0.4 percent and purchases at department stores fell 0.5 percent.

Yesterday's chain-store figures account for about 17 percent of total retail sales, which in turn make up almost half of all consumer spending.

Wal-Mart, the world's largest retailer, posted a 1.4 percent gain in September same-store sales, at the lower end of its forecast. Company officials cited softer demand for home goods and said consumers remained ``concerned with their finances, the cost of living and gas prices.''

Department Stores

Macy's Inc. and J.C. Penney Co. said sales declined. Nordstrom, among the few chains to post a gain, fell short of analysts' estimates.

"Unseasonable weather in large areas of the country and the well-chronicled issues affecting the housing market impacted our sales for the September period," J.C.Penney Chief Executive Officer Myron Ullman said in a statement yesterday.

Excluding autos, gasoline and building materials, the retail group the government uses to calculate gross domestic product figures for consumer spending, sales rose 0.3 percent, following little change the month before. The government uses data from other sources to calculate the contribution from the three categories excluded.

Economists had forecast producer prices would rise 0.5 percent, according to the median of 73 projections. Core prices were forecast to rise 0.2 percent.

Over the past 12 months, producer prices rose 4.4 percent, compared with a 2.2 percent rise in the 12 months through August. Producer prices excluding food and energy rose 2.0 percent in the year through September.

Fed's Preference

Fed policy makers, including Chairman Ben S. Bernanke, have said they prefer to look at core price measures to gauge underlying trends in inflation.

Faced with rising commodity costs, some companies are raising prices to maintain their profit margins.

Kimberly-Clark Corp., the maker of Huggies diapers, said Oct 9 it's raising prices in the U.S. 4 percent to 7 percent on Feb. 3 to counter higher raw material and energy costs. The increases will affect products in the company's consumer tissue and baby and childcare businesses, the Dallas-based company said in a statement.

"The increases are necessary to offset significant inflationary pressure from higher raw material and energy costs," the company said.

Some companies aren't passing on all their cost increases to consumers.

"We pass on a lower rate of price increases to consumers than we are feeling in our input costs," said Stephen Sanger, chairman of food processor General Mills Inc. yesterday at the annual Business Council meeting in Williamsburg, Virginia.

French Annual Inflation Rate Accelerates to 1.6%

Oct 12, 2007 - French annual inflation accelerated in September, spurred by energy costs and tobacco prices.

Consumer prices rose 1.6 percent from a year earlier, higher than the 1.3 percent of the previous month, based on European Union-harmonized methods, Insee, the national statistics bureau, reported today in Paris. From a month earlier, prices rose 0.1 percent. Both figures were below the median expectations of analysts surveyed by Bloomberg News.

Signs of discord are beginning to emerge among European Central Bank monetary-policy makers on the course of interest rates. The ECB's Axel Weber yesterday said the bank may need to raise the key rate to a level that restricts growth in order to control inflation. His colleagues Vitor Constancio and Klaus Liebscher have noted that the stronger euro is helping to contain prices.

"The inflation numbers were very good," said Alexandre Bourgeois, an economist at Natixis in Paris. "Inflation is under control." The ECB aims to keep inflation below 2 percent.

Energy prices increased 1.9 percent in September from a year earlier, while the cost of tobacco rose 6.2 percent, boosted by higher taxes. On the month, fresh food prices jumped 3.2 percent and tobacco rose 1 percent.

The ECB stepped back from plans to raise rates in September, saying it wanted to assess the economic impact of rising credit costs and financial-market turbulence caused by the U.S. housing slump.

"The impact of the financial crisis in the fourth quarter and the first quarter of 2008 should prompt the ECB to reconsider its scenario and progressively consider a monetary response, with two rates cuts in the first half," said David Naude, economist at Deutsche Bank in Paris.

China Trade Surplus Jumps 56 Percent to $23.9 Billion

Oct 12, 2007 - China's trade surplus jumped 56 percent in September to $23.9 billion, adding pressure on the central bank to increase borrowing costs and let the yuan strengthen faster to prevent the economy overheating.

The gap widened from $15.3 billion a year earlier, the customs bureau said on its Web site today, after gaining 33 percent in August. That exceeded the $21.6 billion median estimate of 20 economists surveyed by Bloomberg News.

Export earnings helped push China's foreign-exchange reserves to a record $1.43 trillion at the end of September, a separate report showed. Chinese stocks dropped on speculation the central bank is poised to raise rates for a sixth time this year as cash from overseas sales fuels inflation running at a 10-year high.

"All the money flooding in is a phenomenal problem for policy makers," said Glenn Maguire, chief Asia economist at Societe Generale SA in Hong Kong. "The government may raise rates, but accelerating the pace of yuan appreciation or raising bank reserve requirements are more efficient tools."

The yuan has gained about 10 percent versus the dollar since the end of a fixed exchange rate in July 2005. The currency traded at 7.5080 at 3 p.m. in Shanghai after closing yesterday at 7.5057.

The CSI 300 Index of stocks fell 0.4 percent, after earlier plunging as much as 4.8 percent. It has almost quadrupled in the past year. Inflation reached an annual rate of 6.5 percent in August on food costs and the September figure may be announced as soon as next week.

Borrowing Costs

"Rates are likely to rise again because of the higher inflation rate," said Yao Maogong, head trader at Shanghai Securities Co. in the city.

The one-year lending rate increased to 7.29 percent last month and the central bank told lenders to set aside larger reserves for the seventh time this year.

Speculation an increase is likely comes ahead of the ruling Communist Party's five-yearly congress next week. Central banker Zhou Xiaochuan, who oversaw the revaluation of the yuan and raised borrowing costs for the first time in nine years in 2004, is likely to be moved to a new post after a five-year term, economists predict.

The trade surplus for the first nine months jumped 69 percent to $185.65 billion, topping the $177.5 billion record for all of last year.

M2, the broadest measure of money supply, increased by 18.5 percent in September, according to a report released today -- the eighth straight month that it has exceeded the central bank's 16 percent annual target.

`Anti-China Sentiment'

European finance ministers this week urged China to let the yuan appreciate more quickly against their currency to make its exports more expensive and narrow the gap. Recalls of Chinese- made products such as lead-painted toys have exacerbated trade tensions this year.

"Anti-China sentiment is only going to get worse," said Tim Condon, head of Asia research at ING Groep NV in Singapore, citing U.S. politicians' calls for protectionist legislation in the run-up to next year's presidential election.

Exports rose 22.8 percent in September from a year earlier to $112.48 billion and imports had the smallest gain in three months, climbing 16.1 percent to $88.57 billion.

"Imports are becoming weaker because they are being replaced by domestic production," said Sun Mingchun, an economist at Lehman Brothers Holdings Inc in Hong Kong. "The government should lower tariffs and boost domestic consumption to encourage more imports and the pace of yuan appreciation needs to accelerate too."

Bush: No `Trade War'

U.S. Treasury Undersecretary David McCormick last month said the yuan needs to strengthen faster to boost Chinese consumption and rebalance the world's fourth-largest economy. In the U.S., the Senate Finance Committee in July approved legislation aimed at pressuring China and other countries to allow their currencies to trade more freely.

President George W. Bush said he won't approve any laws that will 'start a trade war or spark protectionist policies,' the Wall Street Journal reported on its Web site today.

Exports to the U.S. rose 15.8 percent in the first nine months from a year earlier and those to Europe jumped 30.8 percent. Shipments to India soared 67.5 percent, the customs bureau said.

Growth in the surplus has slowed from June's 87 percent increase from a year earlier on cuts to export rebates.

The government is concerned that the growth in money supply is helping to fuel increases in property prices. In August, housing prices jumped 20.8 percent in Shenzhen and 12.1 percent in Beijing from a year earlier.

China has the world's fastest-growing major economy. It expanded 11.9 percent in the second quarter from a year earlier, the fastest pace in more than 12 years, on exports and investment.

Japan's Wholesale Inflation Slows for Third Month

Oct 12, 2007 - Japan's wholesale inflation slowed for a third month in September as financial-market turmoil triggered by a U.S. housing slump damped commodity prices and strengthened the yen, making imported materials cheaper.

The producer price index climbed 1.7 percent from a year earlier, extending 3 1/2 years of gains and following a revised 2 percent advance in August, the Bank of Japan said in Tokyo today. The median forecast of 34 economists surveyed by Bloomberg News was for a 1.9 percent increase.

Economists say it's unlikely that producer prices will keep slowing, given that the Japanese currency has since weakened and commodities have rebounded. Yamazaki Baking Co. Japan's largest bread and pastry maker, this week said it would raise prices for the first time in 17 years to cope with higher wheat costs.

"Japan's corporate goods prices will stay on a moderate upward trend," said Hiromichi Shirakawa, chief economist at Credit Suisse in Tokyo and a former central bank official. "As long as the global economy keeps expanding at the current solid pace, demand for energy and raw materials will stay strong."

The yen traded at 117.20 per dollar at 3:11 p.m. in Tokyo from 117.39 before the report was published. Japan's currency has weakened 2.5 percent against the dollar in the past month.

The Japanese economy is ``steadily advancing to the end of deflation,'' Economic and Fiscal Policy Minister Hiroko Ota said.

Food Prices

The government is closely monitoring the effect of recent increases of food prices on households, Ota told reporters. Policy makers are also watching whether small companies can pass rising costs on to clients and protect their profits, she said.

Marudai Food Co. said this week that it will raise prices of its ham and sausages, following rivals Nippon Meat Packers Inc. and Itoham Foods Inc.

Instant-noodle makers Nissin Food Products Co., House Foods Corp. and Sanyo Foods Co. announced price increases last quarter. Global wheat prices have almost doubled in the past six months as adverse weather lowered harvests. The government raised the price of the grain it sells to millers by 10 percent this month.

Wholesale price gains have yet to translate into consumer inflation in the world's second-largest economy.

Core consumer prices, which exclude fresh food, declined 0.1 percent in August from a year earlier. They haven't risen this year. Even so, the wave of price increases for food and household goods is influencing consumers' expectations of inflation, Bank of Japan Governor Toshihiko Fukui said.

Inflation Perceptions

"Though the consumer price index hasn't moved an inch, consumers' inflation perceptions may be changing," Fukui told reporters yesterday. "Their perception is an important factor, and we need to make a policy judgment by reflecting it."

Core consumer prices will increase 'before long' and inflationary pressure 'is mounting gradually,' he said.

The Bank of Japan yesterday kept the key overnight lending rate at 0.5 percent, the lowest in the industrialized world, as policy makers sought more time to assess the effect of the U.S. subprime-mortgage crisis on global economic growth.

Eleven of 31 economists surveyed by Bloomberg News forecast a rate increase by the end of the year.

The central bank's overseas commodity index of 16 raw materials, which includes crude oil, nonferrous metal and steel, soared 23.2 percent in September from a year earlier, the fastest gain in almost a year, according to the central bank.

Small Companies

Small companies, which have less price-setting power than large companies, are struggling to pass energy and material costs to clients and that's eroding their sentiment and profits.

Confidence at small manufacturers and service providers fell in September, according to bank's quarterly Tankan business survey. They estimated profits would drop this fiscal year, a reversal from the growth in income forecast three months earlier.

"Pass-through of costs is happening only among companies that have pricing power," said Yoshimasa Maruyama, a senior economist at BNP Paribas Securities in Tokyo.

Economy Minister Ota said the inability to raise prices may hurt small businesses and the Tankan indicated such concerns.

"Most important is that the economy keeps recovering, and that the recovery of corporate profits spreads to small companies and helps to raise wages," she said.

From a month earlier, Japan's producer prices fell 0.1 percent, the central bank said.

The central bank plans to reshuffle the producer-price index in December and release data using the revised method on Dec. 12, the bank said today.

The revision may lower the index, said Azusa Kato, an economist at BNP Paribas Securities Japan Ltd. in Tokyo.

South Africa Lifts Key Rate to 10.5% to Cut Inflation

Oct 11, 2007 - South Africa's central bank raised its benchmark interest rate by half a percentage point, the third increase this year, as it struggles to bring inflation back within the target range.

The repurchase rate was increased to 10.5 percent, Governor Tito Mboweni said in a televised speech from Pretoria today. That was in line with the forecast of 12 of the 28 economists surveyed by Bloomberg last week. The others expected rates to be left unchanged.

Inflation, which has exceeded the central bank's 3 percent to 6 percent target band since April, may continue to accelerate, fueled by rising food and gasoline costs. The Reserve Bank has increased its key rate by 3.5 percentage points since July 2006, to crimp consumer spending and head off higher inflation.

"If we allow the inflation genie to get out of the bottle, which it's threatening to do, then they run the risk of having to raise rates even more," said Rudolf Gouws, chief economist of Rand Merchant Bank in Johannesburg. "It's a brave decision, but a correct one."

The rand strengthened to 6.743 against the dollar as of 4:30 p.m. in Johannesburg from 6.835 before the rate decision. The yield on the R153 bond, due 2010, rose 8 basis points, or 0.08 percentage point, to 8.88 percent.

Inflation Outlook

The inflation rate, which reached 6.3 percent in August, will probably peak at 6.8 percent in the first quarter of next year and drop to the upper limit of the target range in the second quarter, Mboweni said today. At the last monetary policy committee meeting in August, the central bank forecast the inflation rate would drop below 6 percent by the second quarter.

The Reserve Bank is concerned that price pressures are spreading beyond food and fuel, threatening to keep inflation above the target for longer.

"Even when we exclude food and energy from CPIX, one still finds pressure is on the upside," Mboweni said today. "There is a more generalized set of pressures on inflation, which must be contained, otherwise we run into many problems."

While the Reserve Bank was aware that raising interest rates today won't bring inflation back within the target range in the next few quarters 'at least we are doing something' to curb inflation, Mboweni added.

Unexpected

The monetary policy committee couldn't properly assess, with the data available, if the slowdown in consumer spending will be sustained, Daniel Mminele, a member of the committee, said in a televised interview today.

More than half of the economists surveyed by Bloomberg didn't predict today's rate decision as higher interest rates crimp consumer spending and threaten to undermine economic growth.

"A lot of people never expected the interest rate hike," said Asief Mohamed, chief investment officer of Aeon Global Capital, a Cape Town-based hedge fund. "The increase in interest rates will have a continued negative impact on consumer spending. This is probably the final hike" in rates until at least the end of next year.

Vehicle sales fell an annual 12.9 percent in September, an industry body said on Oct. 2, while retail sales growth slowed for a second month to an annual 4.9 percent in July from 7.1 percent in June, the statistics office said on Sept. 20.

The slowdown in consumer spending has hurt manufacturing, which accounts for 16 percent of the economy, causing economic growth to slow to an annualized 4.5 percent in the second quarter from 4.7 percent in the previous three months.

"It's gone a bit too far now," said Rejane Woodroffe, an economist at Metropolitan Asset Managers in Cape Town. "To have gone a full 50 is a bit too stringent. The economic turndown is worrying."

U.S. August Trade Deficit Narrowed More Than Forecast

Oct 11, 2007 - The U.S. trade deficit narrowed more than forecast in August as exports climbed to a record for a sixth consecutive month.

The gap shrank 2.4 percent to $57.6 billion, the smallest since January, from a revised $59 billion in July, the Commerce Department said today in Washington.

Foreign companies, benefiting from growing demand and a weaker dollar that's made American goods less expensive, have been snapping up Boeing Co. aircraft and General Electric Co. turbines. Rising exports will help keep the economy from falling into recession even as the housing slump persists.

"Strong global demand is going to be a very important source for U.S. economic growth," said Meny Grauman, an economist at Scotia Capital in Toronto who forecast the trade balance would narrow to $58 billion. "We see ongoing strength in exports and ongoing softness on the domestic side."

Economists had forecast the deficit would narrow to $59 billion, from a previously reported $59.2 billion in July, according to the median of 74 forecasts in a Bloomberg News survey. Estimates ranged from $57 billion to $62.3 billion.

Prices of goods imported into the U.S. rose 1 percent in September as costs for oil shipped from overseas jumped to a record, a Labor Department report also showed. Prices excluding oil fell 0.2 percent, the biggest drop since October 2006.

Fewer Claims

A separate report from Labor showed the number of workers filing first-time claims for unemployment benefits declined more than forecast to 308,000 last week.

The trade report showed exports rose 0.4 percent to $138.3 billion, led by demand for food and industrial supplies such as cotton and metals. Imports fell 0.4 percent, the first decline since April, to $195.9 billion.

A jump in petroleum costs prevented imports from dropping even more in August. Petroleum import prices rose to a record $68.09 a barrel.

Rising oil prices may keep the trade imbalance from shrinking in coming months. Crude oil futures reached a record close of $83.32 on the New York Mercantile Exchange on Sept. 20 and have remained near that level since.

The government excludes the effect of prices on trade when calculating its impact on economic growth. On that basis, the gap shrank to $52 billion, the smallest since February 2004.

Trade's Contribution

The U.S. is scheduled to release its advance estimate of third-quarter growth on Oct. 31. Net exports added 1.32 percentage points, the most in more than a decade, to the second-quarter's 3.8 percent growth rate.

A weaker dollar is supporting exports by making U.S. goods cheaper abroad. The dollar is down more than 10 percent since the beginning of 2006 against a basket of currencies of major trading partners, according to Federal Reserve figures.

Also, growth in other countries is outpacing that of the U.S. The economy in countries that use the euro expanded 2.5 percent in the year ended in June, and China grew 12 percent, compared with a 1.9 percent increase in the U.S.

"International is a great opportunity for us," NCR Corp. Chief Executive Officer Bill Nuti said in an interview Sept. 26.

NCR will focus on boosting overseas sales of products such as self-service grocery checkout machines, Nuti said.

GE Turbines

GE, the world's biggest maker of turbines for power plants, said Oct. 8 it will supply six gas-turbine generators and related services to Electricitie de France SA, an agreement valued at more than $750 million. The Fairfield, Connecticut-based company projects revenue from outside the U.S. will increase to $130 billion by 2010, from $80 billion in 2006.

A cheaper dollar may also be boosting gains in tourism to the U.S. The nation's surplus in services grew to a record $9 billion in August mainly reflecting an increase in travel.

The trade deficit with China, the second-largest U.S. trading partner behind Canada, narrowed 5.4 percent to $22.5 billion in August as American companies exported a record $5.9 billion worth of goods.

Demand for American-made goods from South and Central America and from the nations in the Organization of Petroleum Exporting Countries also reached records.

Some U.S. lawmakers and manufacturers say Chinese companies have an unfair trade advantage because China keeps the value of its currency, the yuan, artificially low to stimulate exports.

The U.S. wants China to 'accelerate' its efforts to make its currency more flexible, Allan Hubbard, director of President George W. Bush's National Economic Council, said in an interview on Oct. 5.

HK cutting taxes to shore up financial centre status

Oct 11, 2007 - Hong Kong's government will cut income and corporate taxes by one percentage point to help protect the city's position as an Asian financial centre in its high-stakes race with Singapore.

Salaries tax will be cut to 15 per cent and profits tax to 16.5 per cent in 2008-2009, chief executive Donald Tsang said in his annual policy address yesterday, his first since being elected to a five-year term in March.

The reduction will widen the gap with Singapore, which in February announced a cut in its corporate tax rate to 18 per cent from 20 per cent to lure more financial-services and technology companies. Singapore's top income tax rate is currently 20 per cent.

Mr Tsang had pledged in his election campaign to cut the standard rate of salaries tax and profit tax to 15 per cent within five years.

'We will consider further profits tax relief if our economy remains robust and our public finances stay sound,' Mr Tsang said yesterday.

Hong Kong's corporate tax rate is currently 17.5 per cent, while its salaries tax is 16 per cent. The city's economy in the three months ended June 30 climbed 6.9 per cent from a year earlier after gaining a revised 5.7 per cent in the previous quarter.

Mr Tsang, who has said that his long-term goal is to preserve Hong Kong's status as Asia's top financial centre, also said that the government plans 10 major infrastructure projects in the next five years that will create 250,000 jobs and add HK$100 billion (S$18.9 billion) to the economy annually.

The plans include building an expressway linking Hong Kong with the southern Chinese cities of Guangzhou and Shenzhen, Mr Tsang said. Financing arrangements for a bridge linking Zhuhai city with Hong Kong and Macau are also being finalised, he added.

The city will also spend HK$20 billion to complete a direct road link between Shenzhen and Hong Kong's airport.

Traffic growth at Hong Kong's port, the world's second busiest container port last year, has slowed because of competition from mainland ports.

The Hong Kong government also plans to build a new rail line in southern Hong Kong Island. The line, which will cost more than HK$7 billion, is scheduled to begin operations before 2015.

Mr Tsang said that the city may also start building a line linking Shatin in the New Territories to Central, the downtown business district, in 2010.

In addition, Mr Tsang said that rates for property owners totalling some HK$2.6 billion would be waived for the final quarter of the fiscal year.

S'pore GDP growth remains strong in Q3, up 9.4% year-on-year

Oct 10, 2007 - The Singapore economy continued to register strong growth in the third quarter of 2007.

Advance estimates showed that real gross domestic product (GDP) rose by 9.4 per cent on a year-on-year basis, up from 8.7 per cent in the previous quarter.

The data indicated that the economy is well on track to meet the government's forecast of seven to eight per cent growth for the year.

On a quarter-on-quarter annualised basis, real GDP growth decelerated to 6.4 per cent from 14.4 per cent in the second quarter.

The advance estimate, based largely on data from July and August, gives an early indication of the economy's performance in the third quarter.

Minutes of the Federal Open Market Committee for Sep 18

A meeting of the Federal Open Market Committee was held in the offices of the Board of Governors of the Federal Reserve System in Washington, D.C., on Tuesday, September 18, 2007 at 8:30 a.m.

The Manager of the System Open Market Account (SOMA) reported on recent developments in foreign exchange markets. There were no open market operations in foreign currencies for the System's account in the period since the previous meeting. The Manager also reported on developments in domestic financial markets and on System open market operations in government securities and federal agency obligations during the period since the previous meeting. By unanimous vote, the Committee ratified these transactions.

The information reviewed at the September meeting suggested that economic activity advanced at a moderate rate early in the third quarter. After expanding at a robust pace in July, retail sales rose at a somewhat slower rate in August. Orders and shipments of capital goods posted solid gains in July. However, residential investment weakened further, even before the recent disruptions in mortgage markets. In addition, private payrolls posted only a small gain in August, and manufacturing production decreased after gains in the previous two months. Meanwhile, core inflation rose a bit from the low rates observed in the spring but remained moderate through July.

Private nonfarm payroll employment rose only modestly in August, and the levels of employment in June and July were revised down. The weakness in employment was spread fairly widely across industries. Residential construction and manufacturing posted noticeable declines in jobs, employment in wholesale trade and transportation was little changed, and hiring at business services was well below recent trends. Both the average workweek and aggregate hours were unchanged in August. The unemployment rate held steady at 4.6 percent, 0.1 percentage point above its second-quarter level and equal to its 2006 average.

After posting solid gains in June and July, total industrial production edged up only a bit in August. This increase was attributable to a surge in electricity generation, as temperatures swung from mild in July to very warm in August. After large gains in the preceding two months, manufacturing output declined in August, held down by a decrease in the production of motor vehicles and parts. High-tech output rose only modestly in August, but production gains in June and July were revised up considerably.

Consumer spending appeared to have strengthened early in the summer from its subdued second-quarter pace. Although auto sales were weak in July, real outlays for other goods rose briskly. At the same time, spending on services was up moderately despite a drop in outlays for energy associated with relatively cool weather in the eastern part of the United States. In August, consumption appeared to have posted another solid gain. Although nominal retail sales outside the motor vehicle sector were about flat (abstracting from a drop in nominal sales at gasoline stations associated with falling gas prices), vehicle sales stepped up and warmer weather likely caused an increase in energy usage. Real disposable income rose further in July, as wages and salaries posted a strong gain and energy prices came down. However, household wealth likely was providing a diminishing impetus to the pace of spending, reflecting recent declines in stock market wealth and an apparent further deceleration in house prices. Readings on consumer sentiment turned down in August after having risen in July, and the Reuters/Michigan index remained near its relatively low August level in early September.

The housing sector remained exceptionally weak. Home sales had dropped considerably this year: Sales of new and existing single-family homes in July were down substantially from their averages over the second half of last year. Demand was restrained by deteriorating conditions in the subprime mortgage market and by an increase in rates for thirty-year fixed-rate conforming mortgages. In the nonconforming mortgage market, the availability of financing to borrowers recently appeared to have been crimped even further. Most forward-looking indicators of housing demand, including an index of pending home sales, pointed to a further deterioration in sales in the near term. Single-family starts slid in July to their lowest reading since 1996, and adjusted permit issuance continued on a downward trajectory. Although single-family housing starts had come down substantially from their peak, the drop had lagged the decline in demand, and as a result, inventories of new homes had risen considerably. In the multifamily sector, starts in July were in line with readings thus far this year and at the low end of the fairly narrow range seen since 1997. Meanwhile, house prices generally continued to decelerate.

Orders and shipments of capital goods posted a strong gain early in the third quarter. In particular, orders and shipments of equipment outside the high-tech and transportation sector registered a robust increase in July, and data on computer production and shipments of high-tech goods pointed to solid increases in business demand for high-tech. In contrast, indicators of spending for transportation equipment were mixed. Aircraft shipments in July and public information on Boeing's deliveries suggested that domestic spending on aircraft was retreating somewhat in the current quarter. While fleet sales of light vehicles appeared to have moved up in July and August, sales of medium and heavy trucks remained below the second-quarter average. More generally, surveys of business conditions suggested that increases in business activity were somewhat slower in August than in the second quarter.

Book-value data for the manufacturing and trade sectors excluding motor vehicles and parts suggested that inventory accumulation stepped down noticeably in July from the second-quarter pace. Inventories of light motor vehicles rose again in July and August. The number of manufacturing purchasing managers who viewed their customers' inventory levels as too low in August slightly exceeded the number who saw them as too high.

The U.S. international trade deficit narrowed slightly in July, as exports increased more than imports. Sharp increases in exports of both aircraft and automobiles contributed importantly to the overall gain. Exports of agricultural products and consumer goods were also strong. In contrast, exports of industrial supplies and semiconductors exhibited declines. The value of imported goods and services was boosted by a large increase in imports of automotive products. Higher imports of capital goods excluding aircraft, computers, and semiconductors and of oil also contributed to the overall gain in imports.

Economic growth slowed in the second quarter in most advanced foreign economies, except the United Kingdom. The step-down was most pronounced in Japan, where GDP contracted, but was also substantial in the euro area, where total domestic demand rose only slightly. Although growth remained robust in Canada, data late in the quarter, including retail sales, indicated a more significant weakening in activity. This softness appeared to have continued into the third quarter in some economies. In July, indicators for Europe generally moderated, on balance, from their second-quarter levels; those for Canada and Japan, however, slowed more notably. Most of the readings available on economic developments after August 9, when financial turmoil intensified, were measures of confidence. They dropped, on average, but otherwise were consistent with the indicators reported for July.

Data through July suggested that economic activity in emerging-market countries remained robust. Output in the Asian economies soared in the second quarter, and several countries posted growth at or near double-digit rates. In Latin America, output in Mexico and Venezuela rebounded sharply from earlier weakness. Indicators for China in July pointed to only a modest slowing of output growth from its torrid pace in the first half of the year. The scant data for August received thus far provided little indication that the turmoil in financial markets had a significant negative impact on real economic activity in emerging-market economies.

After rapid price increases earlier this year, U.S. headline consumer price inflation was moderate in both June and July. Although food prices continued their string of sizable increases, energy prices fell in June and July and gasoline prices appear to have dropped further in August. Core PCE prices rose 0.2 percent in June and 0.1 percent in July. On a twelve-month-change basis, core PCE inflation in July was below the comparable rate twelve months earlier. Step-downs in price inflation for prescription drugs, motor vehicles, and nonmarket services accounted for nearly all of the deceleration in core PCE prices. Although owners' equivalent rent decelerated over the past year, this change was largely offset by an acceleration in tenants' rent and lodging away from home. Household surveys indicated that the median expectation for year-ahead inflation declined in August and edged down further in early September to a level only slightly above the reading at the turn of the year; the median expectation of longer-term inflation in early September remained in the range seen over the past couple of years. The producer price index for core intermediate materials rose only modestly in July. Compensation per hour decelerated in the second quarter. Nonetheless, the increase over the four quarters ending in the second quarter was noticeably above the increase in the preceding four quarters and well above the rise in the employment cost index over the same period.

At its August meeting, the FOMC decided to maintain its target for the federal funds rate at 5-1/4 percent. In the statement, the Committee acknowledged that financial markets had been volatile in recent weeks, credit conditions had become tighter for some households and businesses, and the housing correction was ongoing. The Committee reiterated its view that the economy seemed likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy. Readings on core inflation had improved modestly in recent months. However, a sustained moderation in inflation pressures had yet to be convincingly demonstrated. Moreover, the high level of resource utilization had the potential to sustain these pressures. Although the downside risks to growth had increased somewhat, the Committee repeated that its predominant policy concern remained the risk that inflation would fail to moderate as expected. Future policy adjustments would depend on the outlook for both inflation and economic growth, as implied by incoming information. The FOMC's policy decision and the accompanying statement were about in line with market expectations, and reactions in financial markets were muted.

In the days after the August FOMC meeting, financial market participants appeared to become more concerned about liquidity and counterparty credit risk. Unsecured bank funding markets showed signs of stress, including volatility in overnight lending rates, elevated term rates, and illiquidity in term funding markets. On August 10, the Federal Reserve issued a statement announcing that it was providing liquidity to facilitate the orderly functioning of financial markets. The Federal Reserve indicated that it would provide reserves as necessary through open market operations to promote trading in the federal funds market at rates close to the target rate of 5-1/4 percent. The Federal Reserve also noted that the discount window was available as a source of funding.

On August 17, the FOMC issued a statement noting that financial market conditions had deteriorated and that tighter credit conditions and increased uncertainty had the potential to restrain economic growth going forward. The FOMC judged that the downside risks to growth had increased appreciably, indicated that it was monitoring the situation, and stated that it was prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets. Simultaneously, the Federal Reserve Board announced that, to promote the restoration of orderly conditions in financial markets, it had approved a 50 basis point reduction in the primary credit rate to 5-3/4 percent. The Board also announced a change to the Reserve Banks' usual practices to allow the provision of term financing for as long as thirty days, renewable by the borrower. In addition, the Board noted that the Federal Reserve would continue to accept a broad range of collateral for discount window loans, including home mortgages and related assets, while maintaining existing collateral margins. On August 21, the Federal Reserve Bank of New York announced some temporary changes to the terms and conditions of the SOMA securities lending program, including a reduction in the minimum fee. The effective federal funds rate was somewhat below the target rate for a time over the intermeeting period, as efforts to keep the funds rate near the target were hampered by technical factors and financial market volatility. In the days leading up to the FOMC meeting, however, the funds rate traded closer to the target.

Short-term financial markets came under pressure over the intermeeting period amid heightened investor unease about exposures to subprime mortgages and to structured credit products more generally. Rates on asset-backed commercial paper and on low-rated unsecured commercial paper soared, and some issuers, particularly asset-backed commercial paper programs with investments in subprime mortgages, found it difficult to roll over maturing paper. These developments led several programs to draw on backup lines, exercise options to extend the maturity of outstanding paper, or even default. As a result, asset-backed commercial paper outstanding contracted substantially. Investors sought the safety and liquidity of Treasury securities, and yields on Treasury bills dropped sharply for a period; trading conditions in the bill market were impaired at times. Meanwhile, banks took measures to conserve their liquidity and were cautious about counterparties' exposures to asset-backed commercial paper. Term interbank funding markets were significantly impaired, with rates rising well above expected future overnight rates and traders reporting a substantial drop in the availability of term funding. Pressures eased a bit in mid-September, but short-term financial markets remained strained.

Conditions in corporate credit markets were mixed. Investment- and speculative-grade corporate bond spreads edged up; they were near their highest levels in four years, although they remained far below the peaks seen in mid-2002. Investment-grade bond issuance was strong in August as yields declined, but issuance of speculative-grade bonds was scant. Speculative-grade bond deals and leveraged loans slated to finance leveraged buyouts continued to be delayed or restructured. Bank lending to businesses surged in August, apparently because some banks funded leveraged loans that they had intended to syndicate to institutional investors and perhaps because some firms substituted bank credit for commercial paper. Although markets for nonconforming mortgages were impaired over the intermeeting period, the supply of conforming mortgages seemed to have been largely unaffected by recent developments. Broad stock price indexes were volatile but about unchanged, on net, over the intermeeting period. The foreign exchange value of the dollar against other major currencies fell, on balance.

Investors appeared to mark down significantly their expected path for the federal funds rate during the intermeeting period, evidently in response to the strains in money and credit markets and a few key data releases, including weaker-than-expected reports on housing activity and employment. Yields on nominal Treasury securities fell appreciably across the term structure. TIPS-based inflation compensation at the five-year horizon was about unchanged, while inflation compensation at longer horizons crept higher.

Growth of nonfinancial domestic debt was estimated to have slowed a little in the third quarter from the average pace in the first half of the year. The deceleration in total nonfinancial debt reflected a projected slowdown in borrowing across all major sectors of the economy excluding the federal government. Although it decelerated in the third quarter, business-sector debt continued to advance at a solid pace, boosted by a surge in business loans. In the household sector, mortgage borrowing was estimated to have slowed notably, as mortgage interest rates moved up, nonconforming mortgages became harder to obtain, and as home sales slowed and house prices decelerated. M2 increased at a brisk pace in August. The rise was led by a surge in liquid deposits and in retail money funds as investors adjusted their portfolios in response to the turmoil in financial markets.

In preparation for this meeting, the staff continued to estimate that real GDP increased at a moderate rate in the third quarter. However, the staff marked down the fourth-quarter forecast, reflecting a judgment that the recent financial turbulence would impose restraint on economic activity in coming months, particularly in the housing sector. The staff also trimmed its forecast of real GDP growth in 2008 and anticipated a modest increase in unemployment. Softer demand for homes amid a reduction in the availability of mortgage credit would likely curtail construction activity through the middle of next year. Moreover, lower housing wealth, slower gains in employment and income, and reduced confidence seemed likely to restrain consumer spending in 2008. Despite the recent difficulties in some corporate credit markets, financial conditions confronting most nonfinancial businesses did not appear to have tightened appreciably to date. But going forward, the staff anticipated that businesses would scale back their capital spending a touch in response to financing conditions that were likely to become a little less accommodative and to more modest gains in sales. With credit markets expected to largely recover over coming quarters, growth of real GDP was projected to firm in 2009 to a pace a bit above the rate of growth of its potential. Incoming data on consumer price inflation that were slightly to the low side of the previous forecast, in combination with the easing of pressures on resource utilization in the current forecast, led the staff to trim slightly its forecast for core PCE inflation. Headline PCE inflation, which was boosted by sizable increases in energy and food prices earlier in the year, was expected to slow in 2008 and 2009.

In their discussion of the economic situation and outlook, meeting participants focused on the potential for recent credit market developments to restrain aggregate demand in coming quarters. The disruptions to the market for nonconforming mortgages were likely to reduce further the demand for housing, and recent financial developments could well lead to a more general tightening of credit availability. Moreover, some recent data and anecdotal information pointed to a possible nascent slowdown in the pace of expansion. Given the unusual nature of the current financial shock, participants regarded the outlook for economic activity as characterized by particularly high uncertainty, with the risks to growth skewed to the downside. Some participants cited concerns that a weaker economy could lead to a further tightening of financial conditions, which in turn could reinforce the economic slowdown. But participants also noted that the resilience of the economy in the face of a number of previous periods of financial market disruptions left open the possibility that the macroeconomic effects of the financial market turbulence would prove limited.

Although financial markets were expected to stabilize over time, participants judged that credit markets were likely to restrain economic growth in the period ahead. Given existing commitments to customers and the increased resistance of investors to purchasing some securitized products, banks might need to take a large volume of assets onto their balance sheets over coming weeks, including leveraged loans, asset-backed commercial paper, and some types of mortgages. Banks' concerns about the implications of rapid growth in their balance sheets for their capital ratios and for their liquidity, as well as the recent deterioration in various term funding markets, might well lead banks to tighten the availability of credit to households and firms. Tighter credit conditions were likely to weigh particularly on residential investment and to a lesser extent on other components of aggregate demand in coming quarters. Meeting participants also noted that financial market conditions, while seeming to have improved somewhat in the most recent days, were still fragile and that further adverse credit market developments could well increase the downside risks to the economy. Even after market volatility subsided and the recent strains eased, risk spreads probably would be wider and credit terms tighter than they had been a few months ago. Although these developments would likely be consistent with longer-term financial stability, they were likely to exert some restraint on aggregate demand.

In their discussion of individual sectors of the economy, participants noted that recent data suggested greater weakness in the housing market than had previously been expected. Furthermore, recent financial developments had the potential to deepen further and prolong the downturn in the housing market, as subprime mortgages remained essentially unavailable, little activity was evident in the markets for other nonprime mortgages, and prime jumbo mortgage borrowers faced higher rates and tighter lending standards. The faster pace of foreclosures as subprime mortgage rates reset was also seen as posing a downside risk to the housing market. Nonetheless, participants observed that conforming mortgages remained readily available to creditworthy borrowers and that rates on these mortgages had declined in recent weeks. Moreover, conditions in the jumbo mortgage market were expected to improve gradually over time.

Although employment probably was not as weak as the most recent monthly data had suggested, trend growth in jobs had fallen off even prior to the recent financial market strains, and participants judged that some further slowing of employment growth was likely. Indeed, financial services firms had already announced layoffs, largely reflecting mortgage market developments, the demand for temporary workers appeared to have softened, and the most recent weakening in construction employment was likely to continue for a while. Moreover, if declines in house prices were to damp consumption, that could feed back on employment and income, exerting additional restraint on the demand for housing. Nonetheless, to date, initial claims for unemployment insurance did not indicate a substantial and widespread weakening in labor demand, and labor markets across the country generally remained fairly tight, with several participants citing continued reports of shortages of labor from their contacts in some sectors.

Participants thought that the most likely prospect was for consumer expenditures to continue to expand at a moderate pace on average over coming quarters, supported by growth in employment and income. However, some participants saw indications of a possible weakening of consumer spending. Sales of automobiles and building materials had flagged of late, and survey measures suggested that consumer confidence had been adversely affected by the recent financial market developments. Also, a further tightening of terms for home equity lines of credit and second mortgages seemed possible, which could weigh on consumer spending, especially for consumer durables.

Participants reported that recent financial market developments generally appeared to have had limited effects to date on business capital spending plans and expected that business investment was likely to remain healthy in coming quarters. The access of investment-grade corporate borrowers to credit so far remained unimpeded, and rates on investment-grade bonds had declined in recent weeks. Moreover, participants noted that many capital expenditures were internally financed, making them less sensitive to credit market conditions. Nonetheless, the pace of financing for lower-rated firms--including issuance of both speculative-grade bonds and leveraged loans--had slowed sharply over the summer. Participants also noted that standards and terms for commercial real estate credit reportedly had tightened, and that credit availability for homebuilders could be trimmed going forward. In addition, contacts indicated that business executives in parts of the country had apparently become somewhat more cautious and that some were delaying investment outlays in view of heightened economic and financial uncertainty.

Some participants noted that foreign demand remained robust and net exports appeared strong. Port utilization rates reportedly remained high. Participants discussed the turbulence in foreign financial markets and noted that unusually high precautionary demand for dollar-denominated term funding in Europe had added to strains in U.S. interbank markets and contributed to a wide spread between libor and federal funds rates.

Participants made only modest revisions to their outlook for inflation in the period since the Committee's last regular meeting. Still, they recognized that incoming data on core inflation continued to be favorable, and they generally were a little more confident that the decline in inflation earlier this year would be sustained. Inflation expectations seemed to be contained, and the less robust economic outlook implied somewhat less pressure on resources going forward. Participants nonetheless remained concerned about possible upside risks to inflation. Higher benefit costs, rising unit labor costs more generally, reduced markups, and levels of resource utilization both in the United States and abroad that remained relatively high were all cited as factors that could contribute to inflationary pressures. Inflation risks could be heightened if the dollar were to continue to depreciate significantly.

In the Committee's discussion of policy for the intermeeting period, all members favored an easing of the stance of monetary policy. Members emphasized that because of the recent sharp change in credit market conditions, the incoming data in many cases were of limited value in assessing the likely evolution of economic activity and prices, on which the Committee's policy decision must be based. Members judged that a lowering of the target funds rate was appropriate to help offset the effects of tighter financial conditions on the economic outlook. Without such policy action, members saw a risk that tightening credit conditions and an intensifying housing correction would lead to significant broader weakness in output and employment. Similarly, the impaired functioning of financial markets might persist for some time or possibly worsen, with negative implications for economic activity. In order to help forestall some of the adverse effects on the economy that might otherwise arise, all members agreed that a rate cut of 50 basis points at this meeting was the most prudent course of action. Such a measure should not interfere with an adjustment to more realistic pricing of risk or with the gains and losses that implied for participants in financial markets. With economic growth likely to run below its potential for a while and with incoming inflation data to the favorable side, the easing of policy seemed unlikely to affect adversely the outlook for inflation.

The Committee agreed that the statement to be released after the meeting should indicate that the outlook for economic growth had shifted appreciably since the Committee's last regular meeting but that the 50 basis point easing in policy should help to promote moderate growth over time. They also agreed that the inflation situation seemed to have improved slightly and judged that it was no longer appropriate to indicate that a sustained moderation in inflation pressures had yet to be shown. Nonetheless, all agreed that some inflation risks remained and that the statement should indicate that the Committee would continue to monitor inflation developments carefully. Given the heightened uncertainty about the economic outlook, the Committee decided to refrain from providing an explicit assessment of the balance of risks, as such a characterization could give the mistaken impression that the Committee was more certain about the economic outlook than was in fact the case. Future actions would depend on how economic prospects were affected by evolving market developments and by other factors.

At the conclusion of the discussion, the Committee voted to authorize and direct the Federal Reserve Bank of New York, until it was instructed otherwise, to execute transactions in the System Account in accordance with the following domestic policy directive:

"The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee in the immediate future seeks conditions in reserve markets consistent with reducing the federal funds rate to an average of around 4-3/4 percent."