[ForexNews]

The so-called ‘green shoots’ have evolved into more compelling signs of recovery in economic activity, with some of the advanced economies printing positive growth figures already in the second quarter. However, economic conditions remain difficult and headline inflation is in negative territory. Against this backdrop, the leading central banks have decided to keep their quantitative easing (QE) programs in place, with the Federal Reserve slowing the pace of Treasury securities purchases so that it will run until the end of October. The Bank of England actually surprised the markets by increasing the size of its QE program, which as a result will also continue at least till the end of October. Some market economists expect the Fed to also reduce the weekly rate at which it buys MBS and Agencies after the next FOMC meeting on 24 September. That would mean a continuation of QE until the first quarter of next year.

[ForexNews]

ECB officials have until recently suggested that economic conditions likely will warrant holding the policy rate at 1% for an extended period of time. The decision to hold one-year operations at that rate (albeit potentially charging a margin over it) in September and December for unlimited amounts suggests that the ECB believes it is highly likely that it won’t raise rates in 2010. Economists believe that the economy will surprise the ECB on the upside and, as a result, the ECB will announce a first tightening move in June 2010. (The expiration of the gigantic one-year refinancing operation launched in June of this year would provide the ECB with an opportunity to drain a substantial amount of liquidity from the banking system). Moving ahead of the Fed would be justified by the fact that the European economy has suffered a less dramatic blow from the crisis than the American one and should do relatively well once international trade recovers from the late-2008 collapse. As for the BoE, the rate hike would be needed to partly offset the substantial easing effected via its huge QE program (whose impact on money supply is estimated to be equivalent to almost 7ppt of cuts in the Base Rate). Even so, the rate hikes that some is projecting would be smaller and happen later than what is priced into the market.