BEN BERNANKE, the Federal Reserve chairman, has delivered a bleak prognosis for the US economy, suggesting that he supports a new monetary stimulus to battle high unemployment and head off the risk of a downward spiral in prices.
The increasing likelihood of hundreds of billions of dollars of further asset purchases by the Fed – a strategy known as quantitative easing (QE) – will heighten tensions in international currency markets by weakening the dollar further. That may prompt other central banks to follow suit with currency intervention or quantitative easing of their own.
Mr Bernanke yesterday also marched the Fed another step closer to adopting a formal inflation target – a politically contentious goal he has pursued since becoming chairman – saying that most of the body’s officials think that price rises should be “2 per cent or a bit below”.
It is the first time that Mr Bernanke has put that number in a speech and linked it to the central bank’s inflation objective so clearly, a strong signal that the Fed will tie any new stimulus to getting inflation back to the 2 per cent goal.
“Although output growth should be somewhat stronger in 2011 than it has been recently, growth next year seems unlikely to be much above its longer-term trend,” Mr Bernanke said. He added that “inflation is running at rates that are too low” relative to the levels that the Fed thinks are consistent with its mandate.
“The implications for the dollar are stark,” said Michael Woolfolk, strategist at BNY Mellon in New York. “Not only do zero interest rates keep US interest rate differentials negative with most countries, but also QE measures are generally viewed to be corrosive to a currency’s value.”
Democrats in Congress have opposed a numerical inflation target for the Fed in the past because they fear it will cause the Fed to ignore growth. But House Financial Services Committee chairman Barney Frank endorsed Mr Bernanke’s move, saying that it is “entirely appropriate” under the circumstances.
The dollar on a trade weighted basis dropped 0.7 per cent to a new low for the year after Mr Bernanke spoke.
The US Treasury postponed its twice-yearly currency report, putting off a difficult decision on whether to brand China as a currency manipulator. At the same time the administration made a gesture to domestic critics of Beijing by initiating an investigation into China’s support for its environmental technology industry.
– (Copyright The Financial Times Limited 2010)
