Bernanke's aggressive move on monetary policy will have important international consequences, intentional or not. The ECB, Bank of Japan and PBOC will all be under even greater pressure to respond with more aggressive policies as their economies are in no position to tolerate US-exported deflation, especially with oil prices rising. As currency wars are re-ignited, there will be forceful action to retaliate against dollar weakness. Despite the sugar-rush, aggravated economic and political tensions will not support risk appetite, undermining any Canadian and Australian dollar support. By default, the Swiss franc is likely to see renewed upward pressure as defensive capital inflows intensify.
Scholars of American democracy will certainly be very uneasy that the Fed has re-interpreted its dual mandate less than two months before a presidential election, but the key debate for now is domestic action versus international reaction.
There will certainly be important negative international consequences for the Euro-zone and Asia from the Fed's move. The last thing the Euro-zone needs is any currency revaluation which will further undermine competitiveness in a recession. A stronger US economy would of course help global trade prospects, but this will take time to bear fruit and the Euro-zone industrial sector has been given another slap in the face.
Last week, Greece unemployment rose to reported 24.4% for June with Greece and Spain in the unenviable position of having youth unemployment above 50%, a situation which is politically extremely dangerous. Greece's government is powerless to take any independent action as it toils under the troika-led austerity drive. The evidence of the last few days suggests that Greece may be given more time to meet its austerity commitments, but that emphasises the whole problem in that Greece has no self determination. In a democratic void, depression will eventually lead to destabilising political protests.
Spanish and Italian governments remain extremely uneasy over the political implications of accepting a bailout, especially as the Italian technocrat government has no electoral mandate. The apparent decision to give Greece more time is an important indicator that the Euro-zone stresses have actually increased and there will have to be a shift in policies.
The ECB will, therefore, be under intense pressure to take more aggressive monetary action even though this will increase resentment in Germany and fuel seething discontent within the Bundesbank.
The most important Euro-zone economic releases will be the flash PMI readings on Thursday. The ECB has managed to stabilise sentiment, but there will be further major fears surrounding the economy given the Euro area is in recession for the third quarter. Although lower bond yields will ease financing conditions within peripheral economies, there remains no hope of underlying escape from the depression and austerity spiral without a return to growth.
In this context, the PMI releases will be watched very closely with markets generally expecting a small improvement from August readings. A significant factor will be the timing of survey responses and the majority should have been received after the September ECB meeting which should have some positive impact on PMI readings. Given the more favourable backdrop, therefore, any further deterioration would be a major setback for the Euro-zone economy. Any relief surrounding a small improvement is unlikely to be sustained.
The latest Spanish bond auctions will also be watched closely on Thursday to assess how much of the sharp decline in yields has been triggered by stronger underlying demand and how much by a covering of short positions.
The US data releases will be watched closely, although the potential impact will inevitably be diluted by the Federal Reserve's easing last week. The latest housing starts and home sales data is due for release on Wednesday. The latest jobless claims data and Philadelphia Fed index will be issued on Thursday and will both be important in gauging the economy's momentum. If these releases suggest that economy is sinking back towards recession, then the Fed will have to be even more aggressive in its quantitative easing programme given that it has painted itself into a corner with its insistence on meeting employment targets.
Given the importance of the Chinese economy and fears over the risk of a very sharp slowdown, the latest HSBC flash PMI release will be watched very closely on Thursday. With markets generally uneasy over the quality of official Chinese data, the Markit index is likely to take on additional importance and any figure below the 45 level would be received extremely badly.
The latest UK inflation data will be watched closely on Tuesday, especially after the stronger than expected release for August. The headline rate fell sharply from a peak above 5.0% to a low below 2.5%, but the rate moved higher again in August. There are concerns that tuition costs will have an important impact for September and fuel costs are back at record highs. There is a very important risk that inflation will trough at a higher level as structural inflation becomes embedded.
Overall, there looks to be little doubt that the Bank of England will have to give economic weakness greater priority, but the potentially negative Sterling implications of further bond purchases will be much higher if inflation is not under control.
The Bank of England monetary policy minutes will also be watched closely on Wednesday with the balance of forces within the MPC watched closely following the end of Posen's term with McCafferty replacing him on the nine-man team. The latest retail sales data will also be very important on Thursday with a high risk of another erratic release given the Olympics effect.
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