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Euro Fall Tests US Economy

Euro Fall Tests US EconomyEuro Fall Tests US Economy

The European Central Bank’s launch of an aggressive program this week to buy more than €1trillion ($1.12t) in bonds poses important tests for the US economy and the Federal Reserve.

Europe’s new program of money printing — and the resulting fall in the euro —means the US economy must deal with a rapidly strengthening dollar that will make American goods more expensive abroad.

The stronger dollar could slow both US growth and inflation, giving the Fed some incentive to hold off on its plan to raise short-term interest rates later this year from near zero.

US officials have been playing down that scenario, and, more broadly, resisting talk of a global currency war — competitive devaluations by countries eager to keep their currencies as low as possible to protect exports.

The US dollar has already soared in the wake of the ECB announcement Thursday to launch a €60 billion-a-month bond-purchase program, known as quantitative easing or QE. That program will flood the eurozone’s financial system with euros created by the central bank to buy government and private sector bonds. That is expected to boost growth by making eurozone goods and services cheaper around the globe.

The dollar has already gained 15% against the currencies of US trade partners in the past year. Among the factors driving the rise has been the US economy’s strong performance amid a slowing global economy, as well as Fed signals of a likely rise in interest rates this year.

A stronger dollar has three important implications for the US economy, markets and policy makers. First, it tamps down inflation just as the Fed is trying to raise inflation closer to 2%. Second, it hurts exports and therefore economic growth. Lastly, the attraction of US financial assets could heat up markets just as regulators keep watch for dangerous asset bubbles. The US isn’t in a position to serve as the world’s economic engine — as it did in past periods such as the late 1990s — having struggled to breach 3% growth rates since the end of recession in mid-2009.

 

Financialtribune.com