Fed, ECB set to tighten policy

FRANKFURT: Tightening policy by a notch just one day apart, the world’s top two central banks will hope to signal confidence in global economic growth, despite risks of a trade war, currency swings and political turbulence.

The US Federal Reserve is almost certain to raise rates again tomorrow, inching closer to a neutral policy stance, while the European Central Bank is likely to signal on Thursday that its 2.55 trillion (RM11.9 trillion) bond purchase scheme will end this year, a key move in dismantling crisisera stimulus.

Though largely a coincidence, their twin steps suggest the era of cheap central bank cash will soon be over. That indicates major economies are strong enough to stand on their own but also that central banks are keen to replenish their policy firepower before the next downturn.

For the ECB, the next step is likely to be another in a series of incremental moves, as policymakers seek to avoid any potential backtracking, mindful of their two disastrous rate hikes in 2011, which exacerbated the euro zone’s debt crisis.

The euro zone economy has been growing for over five years, employment is at a record high, wage inflation is increasingly clear and bond purchases have done all they could to cut borrowing costs, making ending the scheme the logical next step.

For the Fed, raising rates by 25 basis points to a range of 1.75% to 2% appears an easy call.

The US central bank is meeting both of its objectives – its preferred inflation rate is at 2% and the economy is at full employment.

The question is whether its rate hike projections – three moves both this year and next – move up and whether it expects to hit the so-called neutral interest rate quicker than earlier thought.

“The domestic risks facing the US economy are arguably tilted to the upside,” ABN Amro economist Bill Diviney said.

“A significant amount of fiscal stimulus is coming on stream when the economy is by many measures close to full capacity, and growing at an above-potential pace.”

An overheating labour market would argue for quicker tightening but inflation is expected to stabilise around target and the Fed is likely to be careful in any move above the neutral rate, which neither stimulates not cools the economy.

Another issue to watch will be the Fed’s assessment of the growing external risk from an increasingly long list of sources, like a global trade war, or sovereign risk in places like Italy, Turkey or Argentina. – Reuters