UBS’s Weber Says Fed’s Tapering Negatively Affects Europe

UBS Chairman and former European Central Bank Governing Council member Axel Weber says the Federal Reserve’s plan to reduce stimulus will have a negative effect on the European economy.

“The Fed is doing the right thing for the United States,” Weber, who headed the German Bundesbank until 2011, said in an interview with Bloomberg Television’s Mike McKee on July 12 at the Rocky Mountain Economic Summit in Jackson Hole, Wyoming. “That’s their mandate, but it’s undisputed that through transaction and arbitrage it has spillover effects to other constituencies. It’s coming for Europe at an awkward point in time.”

Fed Chairman Ben S. Bernanke said June 19 that the U.S. central bank is on track to begin reducing its bond purchases later this year and halt the program by around mid-2014 if the economy performs in line with policy makers’ forecasts. European Central Bank President Mario Draghi said July 4 that interest rates in the euro area will remain low for an extended period of time and monetary policy will remain accommodative for as long as needed.

“Very clearly, the normalization of monetary policy in the U.S., which is ahead and on the agenda of the Fed, will impact Europe,” Weber said. “There is a strong correlation between the 10-year U.S. Treasury yield and European Treasury yields at the same maturity.”

Bond Yields

Bernanke’s announcement sent bond-yields spiraling higher in Europe’s periphery, with Portugal’s 10-year yield climbing above 8 percent on July 3 for the first time since November. U.S. Treasuries declined 2.5 percent in the first half of this year, the most since 2009, and the yield on 10-year bonds rose to 2.58 percent last week from as low as 1.61 percent in May.

Portugal’s 10-year bond yield was at 7.36 percent, down 15 basis points, at 3:46 p.m. in Frankfurt today, while the U.S. 10-year note dropped 2 basis points to 2.56 percent. The euro was little changed at $1.3052.

Federal Reserve Governor Daniel Tarullo said in Washington today that the plan to taper the $85 billion in monthly bond buying is “data driven, dependent on the economy” and that monetary policy will remain “very accommodating.” Still, any change in course may force European policy makers to act more determinedly, according to Weber.

Policy Limits

“If there is a de facto tightening happening through what the U.S. is doing, European policy makers need to enact further reforms and need to work on generating dynamics, even harder than if U.S. monetary policy where to stay on the same course,” he said.

The realization of such reforms is mainly in the hands of politicians, and not the ECB, according to Weber. “Monetary policy has reached the limit of what it can do. Fiscal policy has probably also reached a limit and that’s where I think the Europeans now really need to enact those growth agendas.”

With interest rates “very close to zero”, another ECB rate cut might only have “marginal effects,” he said. The Frankfurt-based central bank reduced its benchmark rate to a record low of 0.5 percent in May and left its deposit rate at zero, with Draghi saying he has an “open mind” toward further reductions.

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