Fed's doves will keep cash cheap

Julian Harris
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INTEREST rates will stay “exceptionally low for an extended period”, the US Federal Reserve announced last night.

And despite claims from home and abroad that it is fuelling a fresh bubble, the Fed will continue its lastest phase of quantitative easing (QE2), buying around $75bn (£47.5bn) of Treasury assets every month.

Markets reacted to the news with 30-year Treasury yields spiking to an eight-month high of 4.56 per cent.

And the Dow Jones Industrial Average closed at a two-year high of 11,514, after the Fed’s announcement followed a day of positive news for the US recovery.

But growth remains “at a rate that has been insufficient to bring down unemployment”, the Fed argued, requiring interest rates to stay at zero to 0.25 per cent.

In its final statement of the year, the Federal Open Market Committee (FOMC) repeatedly stressed its “dual mandate to foster maximum employment” as well as price stability.

Last week Bernanke raised the spectre of deflation, saying the US was “getting close to a point where prices start falling.” Even further easing, QE3, was “certainly possible”, he said.

But core producer prices actually rose in November, by 0.3 per cent on the previous month, it was revealed yesterday before the Fed’s statement.

And inflationary pressures are being felt throughout the world, partly from rising commodity prices.

Chinese consumer prices increased by 5.1 per cent last month, while the Bank of England is facing inflationary levels of 3.3 per cent and rising.

One of the FOMC members, Thomas M. Hoenig, voted against the monetary accomodation, arguing that it “would cause an increase in long term inflation expectations that could destabilise the economy”.

The continuation of QE “really sets off inflation fears”, said Jim Paulsen, chief investment strategist at Wells Capital Management.

Last month Bernanke courted controversy by commenting on President Obama’s fiscal stimulus package. On top of the Fed’s measures, Bernanke called for “a fiscal programme that combines near term measures to enhance growth with strong, confidence inducing steps to reduce longer term structural deficits.”

“Fiscal policy may even be a little irresponsible, given the worldwide trend to fiscal austerity, and lack of plans for fiscal consolidation in the US,” he added.

Over half Americans want to rein in the Fed, a poll revealed last week. And 16 per cent want the Fed scrapped altogether.