Tuesday 23 January 2018

Fed's monetary tightening has merely been postponed

The notion that the United States Federal Reserve Bank will totally halt its bond buying is utterly risible, writes Dan White

Dan White

Dan White

THERE may be less to Fed chairman Ben Bernanke's apparent climbdown on US fiscal tightening than meets the eye. With the American economy in a much healthier condition than Europe's, higher US interest rates have been merely postponed.

It was, on the face of it, a humiliating U-turn from the Fed boss. Last week, when addressing the National Bureau of Economic Research, Mr Bernanke oozed sweetness and light. Fed monetary policy, he told his audience, would remain "highly accommodative" for the "foreseeable future".

He seemed to directly contradict his comments of last month that the Fed was getting ready to "taper" (cut back) its bond-buying programme, currently running at $85bn (€65bn) a month. The markets' response to the threat of a taper, beginning perhaps as early as this September, had been immediate and savage. Bonds and equities fell, gold went into freefall and the dollar and interest rates rose.

Last week's comments would seem to represent a complete reversal by Mr Bernanke. The market response definitely indicated that he had reversed course, with the dollar falling and equities rising.

But has he? Did last week's comments mark a complete change of course for Mr Bernanke, or merely a temporary, tactical retreat? Was it a case of Mr Bernanke, conscious of the strength of the market reaction to his original comments, merely soothing investor feathers?

What is certain is that his calming words last week notwithstanding, Mr Bernanke has given no indication of any intention to persist with bond-buying. In other words, the taper remains in place.

If the Fed were to totally halt its bond-buying programme, it would remove the annual equivalent of more than $1 trillion (€766bn) of stimulus from the US economy. Even for an economy the size of America's, with an annual GDP of about $16tn (€12,260bn), that is still an enormous number – the equivalent of more than six per cent of total US economic output.

The notion that this can be achieved without a significant increase in interest rates and a corresponding rise in the value of the dollar on the foreign exchange markets strikes me as being risible. Mr Bernanke has merely moderated the tone of his voice, he has not fundamentally changed the thrust of his policy.

So what significance, if any, does Mr Bernanke's pirouetting have for us on this side of the Atlantic? That, as the man says, depends.

A tightening in US monetary policy and higher American interest rates will force the ECB to make a choice.

Maintaining the value of the euro against the dollar would push up eurozone interest rates with potentially catastrophic consequences for the peripheral countries, including Ireland.

If the German-dominated sado-monetarist bloc on the ECB's governing council gets its way, then this is what will happen.

But will it? Since taking over as ECB president from the entirely unlamented Jean-Claude Trichet in November 2011, Mario Draghi has gradually transformed the council from being an unquestioning instrument of German policy into a body that is far more representative of the eurozone as a whole – a development that has not found favour with either the German government in Berlin or the German central bank, the Bundesbank, in Frankfurt.

Tighter US monetary policy is likely to expose the fault lines within the ECB as never before. For the peripheral countries, a lower euro is an outcome devoutly to be wished for. By making eurozone exports cheaper in third-country markets, including our largest export market, the UK, it would provide a cost-free stimulus at a time when it is desperately needed.

'Maintaining the value of the euro against the dollar would push up eurozone interest rates with potentially catastrophic results'

Viewed from Germany, the situation looks very different. With a jobless rate of only 5.4 per cent, the German economy is at close to full capacity. This means that, unlike in the peripheral countries where importers would be unable to fully pass the cost of dearer imports in the short term, a lower euro exchange rate would feed straight through into higher German inflation.

This would immediately lead to calls for higher interest rates from the German-led faction on the ECB council. How will Mr Draghi prevent this situation from splitting the ECB council down the middle? It will take all of the wily Italian's considerable skills to square this monetary circle.

While most of us here will be hoping the ECB council lets the euro exchange take the strain of any US monetary tightening, there is one group in this country that will be secretly rooting for the Germans – the banks.

With around €55bn of tracker mortgages where the interest rate paid by the borrower is tied to official ECB rates on their books, the Irish-owned banks are losing a bundle, even on compliant loans. Higher official ECB rates, by pushing up the interest rates paid by borrowers on trackers, could drastically reduce these losses.

Homeowners' pain could yet turn out to be the banks' gain.

Clarification

Last week's article, 'Auction protests spell trouble for home repossessions', referred to Allsops' role in the auctions. The company that conducts the auctions is, in fact, called Allsops Space – a 50 per cent Irish- owned firm that does not accept repossessed family homes to its auctions.

Irish Independent

Promoted Links

Business Newsletter

Read the leading stories from the world of Business.

Promoted Links

Also in Business