Monetary Policy: The U.S. and Europe Are Decoupling

Federal Reserve Chairman Ben Bernanke and European Central Bank President Jean-Claude Trichet, who united to fight the worst global recession in seven decades, may be diverging over the outlook for their economies.

The Fed on Aug. 10 said U.S. growth would be slower than anticipated in the "near term," and restarted purchases of Treasury bonds to keep interest rates from rising. Trichet, in contrast, said on Aug. 5 that the euro-area economy was surpassing forecasts, which may pave the way for the ECB to phase out emergency lending measures. The transatlantic divide may be on display on Aug. 27, when each central bank chief was set to address his counterparts and economists at the Fed's annual symposium in Jackson Hole, Wyo. Policymakers from more than 35 nations planned to gather at the Jackson Lake Lodge for debates and hiking trips in the shadow of the Teton mountains.

Attitudes on the economy have shifted sharply in just a few months. In May, the European fiscal crisis forced Trichet to buy government bonds for the first time. And in April, Bernanke discussed how and when to shrink the Fed's balance sheet. Now, the ECB is "looking to the timing of an exit policy, whereas the Fed has obviously put that on the back burner," Mickey D. Levy, chief economist at Bank of America (BAC), said in an Aug. 24 Bloomberg Radio interview with Tom Keene. "The U.S. economy right now is in a soft patch and feels fragile, while in the aggregate the European economies have seemingly weathered the storm much better than people expected."

To Julian Callow, chief European economist at Barclays Capital (BCS), the disparity, which could strengthen the euro against the dollar, has "shades of 2008," a reference to the ECB's decision in July of that year to break with other central banks and raise interest rates even as the credit crisis mounted. But by October 2008, Bernanke was collaborating with Trichet and other central bankers on the broadest coordinated interest rate cut in history. The different outlooks probably reflect the Fed's mandate to achieve "maximum employment" and low inflation compared with the ECB's sole focus on stable prices, says Steven Bell, chief economist at London-based hedge fund GLC and a former British Treasury official.

U.S. indicators are increasingly pointing to slower growth, with gains in private payrolls falling to an average 51,000 monthly pace in May through July, from 119,000 in the first four months of 2010. "The Fed has an employment issue, and Trichet does not," says Diane C. Swonk, chief economist at Chicago-based Mesirow Financial. If weakness in the U.S. economy persists, she says, "I don't think they'll have much choice" but to restart large-scale purchases of mortgages and other assets.

The bottom line: As the Federal Reserve ponders more stimulus, the ECB could soon look for the emergency lending exit ramp.

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