Futures Outlook - An Excerpt from CRB'S Futures Market Service 

G7 central banks likely to maintain negative real interest rates at least through 2009

After Lehman Brothers declared bankruptcy in mid-September  2008, the G7 central banks have all cut their benchmark interest rates. The Fed has cut by 100 bp to 1.00%, the ECB by 100 bp to 3.25%, the UK by  200 bp to 3.00%, Canada by 75 bp to 2.25%, and Japan by 20 bp to 0.30%.

Certainly the ECB and the UK have further to go in cutting interest rates to levels that will be stimulative to their economies. The ECB has been late to the game but has now cut by 100 bp just in the past 4 weeks.  The Bank of England implemented a dramatic 150 bp rate cut on November 6, indicating how seriously it  views the impact of the credit crunch on the UK economy.

G7 central banks are likely to maintain negative real interest rate targets below their inflation rates at  least through 2009 and perhaps longer, depending on how long it takes for the G7 economies to get back  on the path to recovery. Consumer price levels will be falling sharply in coming months due to lower energy and commodity prices and weak demand due to recessionary economic conditions. CPI rates are  currently as follows: US +4.9%, Euro-Zone +3.6%, UK +4.8%, Japan +2.1%, Canada +3.4%. Falling inflation rates will allow G7 central banks to more easily justify further rate cutting. The problem is that G7 central banks  are facing the same liquidity trap that Japan has faced for the past two decades. In a liquidity trap, a  central bank can cut rates to zero and can provide massive quantities of liquidity, but it doesn’t do any  good when banks, businesses and consumers are in such a traumatized state that banks don’t want to  lend and businesses and consumers don’t want to borrow. In that case, excess reserves simply sit unused and are not used to support higher bank lending. The only solution for the central bank in that situation is  to implement quantitative easing (e.g., buying bonds) to force money into the banking system and to  simply let the economy slowly repair itself over time. As seen with the Japanese example, that can be a long and painful process.

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