Trichet's Exit Faces Fed Roadblock as Bernanke Clouds Outlook
Last night’s decision by the Fed to buy an additional $600 billion of Treasuries through June to bolster the U.S. economy may force the ECB to delay the withdrawal of its own stimulus measures, economists said. The Fed’s second round of so-called quantitative easing risks driving the euro higher, threatening Europe’s export-led recovery.
“It’s complicating the ECB’s exit and council members really need to think hard about their strategy,” said Julian Callow, chief European economist at Barclays Capital in London. “They may have to reconsider their plans.”
The Frankfurt-based central bank has said it intends to continue withdrawing its emergency measures, with some policy makers voicing concern about the risks of leaving them in place too long. At the same time, economic divergences within the 16- nation euro region are growing as Germany outpaces debt-strapped nations such as Portugal, Ireland and Greece.
The Fed’s move, which pushed the euro to a nine-month high against the dollar, may have added another headwind.
“The Fed is diluting its currency,” said Juergen Michels, chief euro-area economist at Citigroup Inc. in London. “The ECB won’t be too delighted about a rising euro.”
The single currency climbed as high as $1.4179 immediately after yesterday’s Fed announcement, which kick-started a 33-hour central banking marathon. The euro has risen about 18 percent against the dollar since early June and Citigroup predicts it will appreciate to $1.44 by the end of the year. It traded at $1.4132 at 8:44 a.m. in Frankfurt.
The ECB will leave its benchmark interest rate at a record low of 1 percent today, according to all 55 economists in a Bloomberg News survey. The decision is due at 1:45 p.m. in Frankfurt and Trichet holds a press conference 45 minutes later. The Bank of England will release its policy decision at noon in London and the Bank of Japan makes its announcement at about noon in Tokyo tomorrow.
The ECB meets after Executive Board member Juergen Stark said on Oct. 27 that the bank’s emergency policy settings “will absolutely not be kept longer than necessary.”
While the ECB’s tightening bias sets it apart from the world’s other major central banks, it is still more cautious than those in India and Australia, which this week raised interest rates to stem inflation pressures.
The euro-region economy is showing signs of weakening after expanding at the fastest pace in four years in the second quarter. Growth in the manufacturing industry has slowed from a peak in April and unemployment climbed to a 12-year high of 10.1 percent in September. Exports from Germany, Europe’s largest economy, declined for a second month in August.
A “persistently strong” euro is hurting manufacturers’ price competitiveness, Thomas Lindner, president of Germany’s VDMA machine makers’ association, said this week.
The International Monetary Fund forecasts euro-area growth will slow from 1.7 percent this year to 1.5 percent in 2011, while U.S. expansion will cool from 2.6 percent to 2.3 percent.
“The economies are not performing too differently and still the Fed and the ECB are going in almost exactly opposite directions,” said Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam. “That reflects a deep-seated difference in central bank philosophies. The ECB is happy with moderate growth and moderate inflation; the Fed finds it totally unacceptable.”
Looking to Exit
The Fed’s decision came as voter anxiety over the U.S. economy and unemployment, as well as concerns about President Barack Obama’s fiscal stimulus, helped Republicans seize control of the House of Representatives in mid-term elections.
In Europe, ECB policy makers from Germany, Luxembourg, Belgium, Austria, Italy and the Netherlands have warned against keeping interest rates too low for too long and said further exit steps may be taken in the first quarter of next year.
Up for discussion is when the ECB will return to a bidding process in its lending procedures. It has committed to provide banks with unlimited liquidity in its weekly, monthly and three- month refinancing operations until the end of the year after abandoning its six- and 12-month loans.
Money markets are normalizing, with the rate banks charge each other for three-month loans, or Euribor, rising to 1.049 percent from 0.63 percent in March.
That’s a good reason for the ECB to stop offering banks three-month cash at its benchmark rate of 1 percent because it discourages interbank lending, said Marco Valli, chief euro-area economist at UniCredit Global Research in Milan.
Bundesbank President Axel Weber has also called for an end to the ECB’s bond-purchase program, arguing its risks outweigh any benefits.
Investors have continued to dump Irish, Portuguese and Greek government bonds even after the ECB started buying them on the secondary market in May to ease tensions. The premium on Irish 10-year bonds over German bunds stood at 505 basis points at 8:53 a.m. in Frankfurt, Portugal’s spread was at 386 basis points and Greece’s reached 838 basis points.
“Weber has a point but it’s too early for the ECB to adopt the line and embark on an official tightening policy,” said Karsten Junius, senior economist at Dekabank in Frankfurt. “If the euro gains considerably and tensions on bond markets persist, the ECB may have to extend its support for the banking system well into 2011 and keep rates at a record low into 2012.”
Still, a stronger euro may not fully shield Europe from rising inflation pressures. The Fed’s monetary easing may spur investors to seek higher-yielding assets such as commodities, boosting prices that are already rising due to stronger demand in emerging economies.
Crude oil prices denominated in dollars have jumped 17 percent since Aug. 31 and are up 6.3 percent in euro terms. That pushed euro-area inflation to 1.9 percent in October, the highest level in almost two years. The ECB aims to keep the rate just below 2 percent.
“The time will come for the ECB to look at inflation again,” said Laurent Bilke, global head of inflation strategy at Nomura in London, who expects a breach of 2 percent at the beginning of next year. “It doesn’t mean they’ll raise rates in the next three months, but we’re approaching levels the ECB will pay attention to.”
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