World Economy

Federal Reserve to Take Away the Punch Bowl

Federal Reserve to Take Away the Punch Bowl
Federal Reserve to Take Away the Punch Bowl

Unless it springs a major surprise, the US Federal Reserve will call time this week on its program of government bond purchases, which at one point was pumping $85 billion a month into financial markets and the economy.

James Bullard, who heads the St. Louis Fed, has suggested that sticking with bond purchases for a few more months would give policymakers time to assess a deteriorating inflation outlook, Reuters reported.

That helped markets to calm from a violent sell-off 10 days ago but economists expect the Fed to turn off its money taps on schedule on Wednesday, while giving accompanying assurances that it will respond if a global downturn threatens its economy.

“We remain optimistic that the recent upshift from 2 percent to 3 percent growth will be sustained,” economists at Bank of America Merrill Lynch said in a note.

It may well be that the Fed keeps US interest rates virtually at zero for longer given tumbling energy prices and an absence of wage growth. Investors have already pushed expectations for an initial rate rise back several months to late next year.

  Global Concerns

Global concerns are centered on the extent of China’s slowdown and the malaise in the euro zone, over which the specter of deflation still hovers.

Results of stress tests on European banks, announced on Sunday, showed 25 banks had failed as of the end of 2013 but most have since repaired their finances.

The European Central Bank has staked its reputation on this exercise, hoping it will draw a line under years of financial and economic turmoil. But whether it leads to a resurgence of bank lending is uncertain given the euro zone’s economic doldrums.

“Thinking that lending somehow can lead GDP is an illusion, and I don’t know how that has somehow crept into the policy debate,” said Erik Nielsen, chief global economist at Unicredit.

“Businesses need to believe in an increase in the demand for their products before asking for credits, and now that external demand growth is no longer there, this is when the euro zone needs demand stimulus.”

Euro zone inflation data in the week to come will show whether the threat of deflation has eased at all. The consensus is for the headline rate to have edged up to 0.4 percent in October but that will bring little comfort.

Germany’s Ifo sentiment survey will give a glimpse of how things are going for Europe’s largest economy in the last three months of the year. It contracted in second quarter and is unlikely to have done a lot better in the third.