Central Banks- A Macro View

Capital flows into emerging markets, driven by a combination of expected stock market gains, currency appreciation, and in some countries high interest rates, have been of increasing concern for central banks. Across the emerging market countries, FX reserves surged by $209 billion to $3.2 trillion in first quarter of 07 after a $216 billion increase in the last quarter.

Authorities struggling to grapple with large capital inflows would welcome some dampening of risk appetite. Meanwhile, lower export growth, modest inflation, and accumulated real currency
appreciation make central banks less willing to accept further nominal appreciation.

This already prompted heavy capital controls in Thailand, controls that were faintly echoed in prudential or monetary measures in China, Korea, and the Philippines. Vietnam also is reportedly looking at imposing capital controls.

The relative weakness of the yen only exacerbates the pressure on Asian central banks, especially in Korea, Malaysia, and Taiwan, to counter currency appreciation. The conflict for Asian central banks would be far less daunting if investors lessen their asset demands.

In the EU region, the ECB will likely hike again in June by 25 basis points. Chances of further hikes exist, if GDP and/or credit growth fail to moderate, but the ongoing appreciation of the euro limits those risks.