IN A dramatic move that took markets by surprise, the US Federal Reserve announced last night it would buy $300 billion in long-term treasury securities and another $850 billion of mortgage-backed securities issued by nationalised financial institutions Fannie Mae and Freddie Mac.
The move was viewed as an attempt to boost the US economy by essentially printing money to get credit flowing again. “Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending,” the Federal Reserve said in a statement explaining last night’s move.
“Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. US exports have slumped as a number of major trading partners have also fallen into recession,” the Federal Reserve added. “In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability.”
The size of the move surprised investors, causing the Dow Jones stock index to jump almost 200 points. However, the announcement hurt the dollar, which hit a twomonth low against the euro on fears that the measures would undermine the currency.
The move came after European Central Bank (ECB) president Jean- Claude Trichet signalled there would be a recovery in the euro-zone economy next year but hinted similar tactics to those taken by the US may be required.
Asked whether the ECB could follow its US and British counterparts in directly buying assets to boost the eurozone economy, Mr Trichet said: “We are considering at the moment whether it is appropriate to take complementary measures which would not necessarily be identical with those that our colleagues have taken.”
“The year 2009 will be very, very difficult,” Mr Trichet told Europe 1 radio yesterday. “At the same time, there is quite general agreement between all public and private institutions that 2010 may be the year of moderate recovery in growth.”
Mr Trichet’s predictions of a recovery echo similar comments this week from Federal Reserve chairman Ben Bernanke, who said the US could start recovering next year if there is enough political will to solve the bad debt problems in the banking sector.
The Federal Reserve had already exhausted its main monetary policy lever by lowering benchmark interest rates to between zero and 0.25 per cent last December, and many had expected it would soon follow Japan and Britain in pumping money directly into the system.
“This is a pretty dramatic move,” said James Caron, head of global rates research at Morgan Stanley in New York. “They are trying to bring down all consumer rates.”
Mr Trichet yesterday appeared to rule out reducing interest rates to zero. “As I have said when I have reported on the governing council’s deliberations, we feel that there are a number of disadvantages associated with zero rates,” he said.
Mr Trichet’s assessment comes as EU leaders gather today and tomorrow in Brussels to try to co-ordinate their response to the financial and economic crisis ahead of the G20 meeting of world powers in early April.
Against a backdrop of rising unemployment and social unrest across Europe, EU leaders are expected to propose a doubling of the resources of the International Monetary Fund (IMF) to help states that face economic collapse.
They will also back the creation of a new regulatory and supervisory system for the world economy and review EU states’ stimulus plans, which are expected to create ¤400 billion of spending to kickstart the economy.
But calls this week from the US for EU leaders to agree to increase the size of their stimulus plan are likely to be resisted. Berlin and Paris are anxious that the budget deficits of euro-zone states do not balloon out of control during the economic crisis, undermining the stability of the euro. EU leaders are expected to sign up to summit conclusions tomorrow calling for a “swift and credible reversal of the fiscal expansion” in conformity with the EU’s budget rules.
Taoiseach Brian Cowen, Minister for Finance Brian Lenihan and Minister for Foreign Affairs Micheál Martin will attend the European summit, which will also decide whether an extra €5 billion can be released from the EU’s budget to fund energy projects.