Greenspan pilots US towards soft landing

So far the US Federal Reserve appears to be doing a good job of bringing the US economy in for a soft landing. Policymakers across the world are looking at the US economy and crossing their fingers that the next year or so will see only a small downturn in demand and not a slump into a full blown recession.

For Europe, as almost everywhere else in the world, there are a number of matters which depend on the future of the US economy and this is as true of Ireland as anywhere else given the openness of the economy here.

At its meeting last week the Fed, as expected, left interest rates unchanged. But this was only six weeks after a hike of a half percentage point (just weeks before the European Central Bank followed suit). As a result it was probably too early to raise rates again in any case.

With the presidential election looming in November, the last chance to raise rates in the US is likely to be the meeting at the end of August.

But will this happen? So far, most of the signs are that the US economy is slowing down nicely, although the Fed did warn about "heightened inflationary risks in the foreseeable future".

Nevertheless, retail sales fell in April and May, employment was down and unemployment is very slightly higher. Combined with wobbly share prices and higher oil prices, this could well point to a slowdown. There is still some data pointing in the other direction, particularly durable goods' orders which surged in May after a fall in April.

In addition, some analysts point to consumer confidence which is near record highs. Combined with the fact that, for the past two years, the US economy has slowed in the second three months of the year before rebounding strongly from July onwards, it means that nothing can be taken for granted.

The likelihood remains that Fed chairman Mr Alan Greenspan has got it right and the US economy is on course for a soft landing, which most people assume to be interest rates around current levels and a slowdown in the economy from growth rates of around 5 per cent to between 2.5 per cent and 3 per cent.

One impact of a fall in US growth would be a weakening in the dollar. A hard landing which actually saw recession could mean a crash in its value. For the euro, weakening would be good news and would be likely to mean the currency would move through parity once again.

At the same time sterling would probably move with the dollar and a substantial weakening would be quite possible. For Ireland there are obvious dangers here. A strengthening of the euro would take much of the unwanted inflationary pressures off the economy. But, combined with a substantial weakening of sterling it could quite quickly cause competitiveness problems, particularly for exporters to the UK. Many of these exporters have grown quite reliant on the large margins which the weak euro has allowed over recent years.

A weakening US economy would probably have an impact on stock markets and impact on current valuations as it hit corporate profits. That would have a knock-on effect for stock markets across Europe. The Economist recently outlined a forthcoming analysis from the chief economist of American Express Bank, who believed there was still a 40 per cent chance of a hard landing in the US. He argued that, in theory, this could be offset by stronger domestic demand and would reduce inflation, allowing other central banks to cut interest rates to boost domestic spending.

If this were to happen there may be little impact from a US slowdown. However, central banks are often not as keen to cut interest rates as they are to raise them and there has to be a doubt whether the European Central Bank would cut rates quickly enough in this scenario.

For Ireland, the hope must be that the US economy is slowing slightly, allowing the euro to appreciate a little. So long as European markets remain strong, US companies exporting from here will still have buoyant markets and the impact will be more limited than in the US itself. A hard landing of course risks damaging US corporations here and would have a far more adverse impact.