Fed’s loose policy stirs currency war fears

Bloomberg

Euro, yen, and U.S. dollar banknotes of various denominations are arranged for a photograph in Soka City, Saitama Prefecture, Japan, on Wednesday, Aug. 29, 2012. The dollar headed for a monthly advance versus the yen before U.S. data forecast to show consumer spending rose the most since February. Photographer: Kiyoshi Ota/Bloomberg

Alan Wheatley London

The US Federal Reserve’s ultra-loose monetary policy is regarded as a root cause of the “currency wars” that some see as a looming threat to the world economy, but do not expect the US central bank to signal a shift back to normal any time soon.

The Fed, whose policy-setting Federal Open Market Committee (FOMC) concludes a two-day meeting tomorrow, said last month that it expected to keep short-term interest rates exceptionally low until the US unemployment rate fell to 6.5 percent, inflation permitting. That goal is still distant.

Figures on Friday are likely to show that the jobless rate was unchanged in January at 7.8 percent, while the economy created 155 000 jobs, the same as last month, according to economists polled by Reuters.

So it would be a huge surprise if the Fed were to do anything other than reaffirm last month’s decision to anchor short-term interest rates in a range of zero to 0.25 percent and to keep buying $85 billion (R760bn) of bonds each month to hold down long-term rates.

The only question mark is whether the FOMC vote will be unanimous now that Richmond Fed president Jeffrey Lacker, who opposes the current round of bond-buying, has rotated off the panel, according to Harm Bandholz, an economist at UniCredit Bank.

Most economists expect the Fed to keep its open-ended bond-buying programme in place well into next year, even though the economic news flow and market confidence are improving markedly.

True, tomorrow’s preliminary report on fourth-quarter gross domestic product (GDP) is likely to show that growth slowed to an annualised rate of 1.2 percent from 3.1 percent in the July to September period.

And the current quarter will also be soft as the expiry of a 2 percent payroll tax cut is dampening spending.

But then Bandholz expects an average growth rate of 2.8 percent over the rest of the year. That would be the strongest three-quarter period of the recovery so far, he said.

“The outlook has improved a lot in the US. I’ve been on the cautious side for the last three years, but this time I’m a bit more bullish,” he said.

The recovery in housing would add at least half a percentage point to GDP growth in 2013, while capital spending was likely to revive now that uncertainty over budget talks in Washington had been largely allayed, Bandholz said.

“There’s a lot of pent-up demand in the system. I don’t think all these investments have been abandoned; they’ve just been postponed,” he said.

Gustavo Reis, an economist with Bank of America Merrill Lynch in New York, said concerns about the costs of money-printing were likely to spread but would be offset by uncertainty over the impact on growth of fiscal tightening in the US and Europe.

“All told, although global activity seems more robust now than at any point in 2012, we expect policymakers to continue to worry predominantly about downside risks,” he said.

The bank did not expect the Fed to consider halting asset purchases before 2014, while the latest episode of monetary easing announced by the Bank of Japan was likely to be “long-lived and significant”.

Many economists argue that bold monetary action is long overdue in Japan, whose nominal output has not grown in 20 years, saddling the government with a debt-to-GDP ratio of more than 220 percent.

Last week Olivier Blanchard, the chief economist of the International Monetary Fund, called talk of currency wars overblown and said countries had to pull the right policy levers to get their economies back on track, with corresponding consequences for exchange rates.

Tellingly, Chancellor Angela Merkel voiced German concerns last week that Japan might be deliberately seeking to cheapen the yen to give its exporters a competitive edge.

In a quiet week for economic data in the euro zone, the focus is likely to remain on the euro, which has been rising briskly as traders price in the policy shifts that Blanchard had in mind. – Reuters