Fed will weigh up ECB's stimulus push as it readies rates message

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[October 24, 2015]  By William Schomberg
 
 LONDON (Reuters) - The European Central Bank's signal that more stimulus is coming for Europe's economy could complicate the U.S. Federal Reserve's own message this week about when it might move in the opposite direction.

ECB President Mario Draghi caused the dollar to jump against the euro on Thursday when he said the ECB was studying new ways to fight off deflation and spur growth that may be announced as soon as December.

The Fed was already treading cautiously about whether it would begin raising U.S. interest rates in December.

"The ECB's move increases the probability of the Fed thinking twice about it," said Marco Valli, the chief euro zone economist at UniCredit in Milan.

"They will want to give the impression that they remain on track to raise rates at the end of the year," Valli said. "But obviously, after the ECB played tough, they will seek to avoid giving the impression that they are pre-committed."

Seven years after the Fed cut rates to nearly zero to fight off the effects of the financial crisis, rich and developing countries around the world are waiting for it to reverse course.
 


Figures due on Thursday, a day after the Fed's statement, are likely to show U.S. economic growth slowed to an annualized 1.7 percent in the third quarter, according to a Reuters poll of economists, down from 3.9 percent in the second quarter as a weaker global economy took its toll.

But assuming the U.S. Congress strikes another last-minute deal before a Nov. 3 deadline to avoid defaulting on its debt, growth in the United States is expected to pick up toward the end of the year and remain strong in 2016.

Fed Chair Janet Yellen and other officials have said they expect a rate increase will be needed by the end of this year. But two Fed governors urged caution last week, and financial markets don't expect a move until next year.

A first move had been widely expected in September. The Fed was put off then by the turmoil in China's stock markets as the Chinese economy slowed.

On Friday, China cut rates for the sixth time in less than a year, announced on Friday. That might help ease concern about its outlook.

But with the ECB considering measures such as a further cut in interest rates or ramping up its bond purchases, the Fed will have to consider the pros and cons of widening the divergence of monetary policy on the two sides of the Atlantic.

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Ethan Harris, global economist with Bank of America/Merrill Lynch, said he took a different view to the consensus and felt the Fed might be encouraged to act by Draghi's words.

The prospect of more ECB stimulus might hurt the U.S. economy by pushing up the value of the dollar. But the effect may be more than offset by other effects of the announcement, such as lower U.S. market interest rates and gains in U.S. stock market prices, he said.

"Everyone assumes that this is going to stop the Fed. I think at this stage it may even encourage the Fed to hike," Harris said.

The Bank of Japan is also considering an expansion of its stimulus efforts, after the economy shrank in the second quarter and might have slipped back into recession.

Six of 13 economists in a Reuters poll said the BoJ will add to its stimulus when it meets on Friday, with inflation forecast to be just 0.1 percent in the fiscal year to March 2016.

However, several BoJ policymakers are wary of moving at Friday's meeting. They cling to the hope that Japan's economy will weather the slowdown from abroad.

In Britain, where the economy has been growing for more than two years, preliminary figures for the third quarter, due on Tuesday, are expected to show a slight slowdown.


But the cooling is unlikely to cause the Bank of England to reconsider its plans. Most economists expect it to raise rates early next year.

(Additional reporting by Leika Kihara in Tokyo, editing by Larry King)

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