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US Fed springs a surprise,decides to stick to bond-buying stimulus

Bank cites strains in US economy from tight fiscal policy and higher mortgage rates

Written by Reuters | Washington | Published: September 19, 2013 2:59:09 am

The US Federal Reserve on Wednesday said that it would continue buying bonds at an $85 billion monthly pace for now,expressing concerns that a sharp rise in borrowing costs in recent months could weigh on the US economy.

The decision surprised financial markets that were braced for a reduction in the central bank’s economic stimulus. Citing strains in the economy from tight fiscal policy and higher mortgage rates,the US Fed decided against a tapering of asset purchases that investors had all but priced into stock and bond markets.

“The tightening of financial conditions observed in recent months,if sustained,could slow the pace of improvement in the economy and labour market,” the US central bank said in a statement explaining its decision.

Stocks rallied on the US Fed statement,with the S&P 500 index hitting a record high. The dollar fell to a seven-month low against the euro,while prices for US government bonds rose sharply.

“The economy is stabilising but it’s not growing,” said Douglas Borthwick,managing director at Chapdelaine Foreign Exchange in New York. “The Fed has always said they were data-dependent and data would determine the timing of the taper. But the data that has come out over the past month hasn’t been good.”

In its statement,the Fed said the economy was still making progress,even in the face of tax hikes and budget cuts in Washington. “Taking into account the extent of federal fiscal retrenchment,the committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy,” it said.

And policymakers made clear they were still mulling exactly when to ratchet back their bond-buying stimulus.

“The committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases.”

RBI gets more headroom to do away with R restrictions

New Delhi: The US Federal Reserve’s move to keep the economic stimulus programme unchanged could come through as a shot in the arm for most emerging market economies,including India.

The Indian markets on Thursday are predicted to rally on the US Fed’s decision against trimming its bond purchases. The decision — first tentative step by the central bank to wean the world off its stimulus programme that has helped prop up the US economy and equity markets across the globe for much of the year — is also expected to determine interest rates in India,especially since the Reserve Bank of India postponed its monetary policy review from September 18 to September 20,primarily to see what the Fed does. The Fed’s decision essentially gives RBI Governor Raghuram Rajan much more headroom to move in favour of doing away with some of the short-term restrictions on capital outflows placed by his predecessor in August to prop up the rupee.

A reversal of capital inflows had the potential to hit the rupee as financing the current account deficit,which was 4.8 per cent of GDP in 2012-13,would have had became difficult. CAD is likely to be $70 billion in 2013. In light of the Fed move,the rupee should gain further as the worries about foreign fund outflows are expected to recede. Inflation worries notwithstanding,the Fed move also offers Rajan a freer hand in the issue of monetary easing.

The Indian bourses had essentially priced in a $10-$15 billion cut in the US stimulus and there were fears that a larger cut may lead to a sharp fall in equities on concerns that foreign investors will take money out of the country. India witnessed net capital inflows totaling $88 billion in 2012,largely due to global quantitative easing,according to global brokerage Nomura.

— ENS Economic Bureau

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