Inflation now seen as too low in US. ECB revises up growth forecasts
The US recovery is now over a year old but the pace of growth slowed in the second quarter, raising concerns for both investors and the Federal Reserve. Firms are still creating jobs in the US but not in sufficient numbers to make an appreciable dent in the unemployment rate, which has fallen at a glacial pace from 10.1% to the current 9.6%, according to Bank of Ireland’s latest Bulletin which was published today, 6 October 2010.
Author of the Bulletin, Dr. Dan McLaughlin, Group Chief Economist, Bank of Ireland said: “Unlike other central banks the Fed’s mandate includes the maintenance of full employment and so the expectation has grown that they will increase their buying of Government bonds in an effort to push long term notes down further = additional quantitative easing in other words, or QE2 for short. The most recent Fed statement flagged this possibility but also included the belief that inflation is now too low in the US. Consequently, we now have two possible triggers for QE2 = a further period of sluggish growth or a series of weak inflation readings.
“The market now also believes that the US will not start to raise rates until the spring of 2012 and this along with the chance of QE2 has pushed longer term notes down to new lows – two year rates are now around 0.6%, for example, and this has put downward pressure on the US dollar.
“A number of the US’s trading partners are not prepared to see their currencies rise against the dollar, including Japan and China, but the euro area has no such policy. Moreover, economic activity surprised to the upside in Europe over the summer months and the ECB has revised up its forecasts of GDP and inflation for this year and next.
“Consequently two year euro rates have risen to around 1.5% or 0.85% above dollar rates from a flat spread in late May. The net impact is that the euro has risen sharply against the US dollar, and we are revising our FX forecasts to take account of the new Fed policy on inflation. We now expect the euro to end the year around $1.35 with an upside risk although it is likely to fall back somewhat near term as it is very over-bought”, concluded Dr. Dan McLaughlin.
Dr. Dan McLaughlin
Group Chief Economist
Bank of Ireland Global Markets
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Bank of Ireland
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