The focus was briefly turned away from Greece last night with the result of the Fed meeting and also the Fed Chairman’s second ever post-meeting press conference. In sum, the Fed was more cautious on the economy but, at the same time noted that underlying inflation had picked up, something which they think will dissipate. Still, it’s not a comfortable combination of events for any central bank to be dealing with. The prospect of a third round of quantitative easing still appears to be a distant one, with the Fed statement offering no hints that this was being considered. Nevertheless, with 0.4% knocked off the Fed’s growth projection for this year, it appears that the market feels vindicated in its caution over recent weeks, stocks especially. The dollar firmed towards the end of the NY session, something which continued during Asian hours.
Guest post by FXPro
Commentary
Signs of Trichet relenting on further rate hike? There were signs yesterday that the ECB may be wavering on its commitment to tighten rates further in July. After a meeting of the European Systemic Risk Board, Trichet admitted that financial stability signals are flashing red and that the link between sovereign debt problems and the exposure of banks to them “is the most serious threat to the financial stability in the European Union”. As we outlined last week (http://bit.ly/kBh1Z9), a rate increase by the ECB at this point in time would be the biggest policy mistake during its history (and there’s some tough competition).
EU summit to discuss financial alchemy. EU leaders gather in Brussels today where they will discuss the way ahead for Greece. At present, they have the roadmap towards a new aid package which they are looking to finalise early July. However, just how they hope to achieve 100% voluntary restructuring of Greek debt remains just as murky as was the case when it was first floated last month.
Is the UK thinking about QE2. The main bone for markets to gnaw on in the June Bank of England MPC minutes was the suggestion that for some members “it was possible that further asset purchases might become warranted if the downside risks to medium-term inflation materialised”. Of course, we’ve had one member (Posen) voting for an expansion of QE for eight months now and he’s looked pretty isolated, especially during the early part of this year. The minutes suggested that, although he’s not going to be joined by anyone else in the near future, there are some who are at least becoming a little more sympathetic towards his thinking. This seems to have come about from the fact that “the current weakness of demand growth was likely to persist for longer than previously thought”. That said, the current outlook still remains divisive for the committee, with two members still voting for higher rates (Weale and Dale). The fears remained unchanged, namely that the margin of spare capacity is less than generally believed, together with higher CPI becoming ingrained in the price-setting behaviour of household and businesses. Sterling’s reaction is understandable, having weakened half a big figure vs. the USD on the back of the release. Notionally of course, the Bank has never chosen to rule out an expansion of the asset-purchase facility first started back in 2009, but these minutes offer the first hint that it may be starting to enter the mainstream policy debate, rather than being confined to a lone but steadfast committee member.
Germany now considering tax cuts. Most of Europe is engaged in unprecedented austerity and hardship these days, but for Germany it is the best of times. Indeed, CDU Parliamentary Chief Volker Kauder remarked in a television interview last night that the economy was performing so strongly that the party was considering introducing substantial income tax cuts for low/middle income earners worth up to EUR10bln, to make up for bracket creep over the past few years. This was despite the increased costs associated with contributing to the various bailouts for Greece, Portugal and Ireland. The CDU’s coalition partner, the FDP, is especially keen to get a deal wrapped up by the end of the summer. Tax cuts in Germany are not a done deal, however current Finance Minister Schauble is against the proposal, as are the Greens.
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