Policy change on interest rates unlikely

US FEDERAL RESERVE:LAST AUGUST, with job creation stalled and the stock market on the slide, the US Federal Reserve made its first moves towards another round of quantitative easing.

In a speech at the Fed’s annual gathering, Ben Bernanke, its chairman, began to signal the prospect of more asset purchases to drive down long-term interest rates and stimulate the economy. The $600 billion round of purchases that became known as QE2 was eventually launched last November. History seemed to be repeating itself after this week’s stock market plunge, leading many in the markets to speculate about another round of easing, or “QE3”. But there is a big difference between this year and last, which means the Fed is unlikely to make a policy change when it meets to set rates on Tuesday. That difference is inflation.

The Fed prefers to look at “core” measures of inflation that exclude volatile food and energy prices. Last autumn they were about 1 per cent – well below the Fed’s goal of 2 per cent or a bit below – and falling. This year, they are around 1.5 per cent and rising.

“On one half of the mandate – growth – there is a reasonably good case for more policy stimulus,” said Paul Dales, senior US economist at Capital Economics in Toronto. “The difference from last summer is the inflation picture.”

Even though the downside risks to the economy have got worse, most officials on the rate-setting federal open market committee still expect growth to bounce back later this year, as supply chains disrupted by the tsunami in Japan get back to normal and lower oil prices allow consumers to start spending again.

Anything the Fed could do now would take time to feed through to the economy. Until there are signs that the economic slowdown is more permanent, or that inflation is sliding back towards levels where deflation is a danger, there is little appetite for trying more asset purchases today. – (Copyright The Financial Times Limited 2011)