Fed and ECB Monetary Policy Outlook for Q4 2012

Ahhh, how fast time flies! We’ve got less than three months left for 2012. Let’s take a look at what two of the most influential central banks–the Fed and the ECB–have done and what they could still do in the last quarter of the year.

Federal Reserve (Fed)

Federal Reserve
Current Stimulus Programs Open-ended quantitative easing, Operation Twist
Federal Funds Rate 0.00% to 0.25%

When it comes to launching stimulus measures, the Fed is always ahead of the pack. It’s arguably one of, if not the most, proactive central bank in supporting its economy.

The FOMC Statement in September has been the most significant one for this year so far. There were two main takeaways from Federal Reserve Chairman Ben Bernanke‘s statement.

One, American central bankers have implemented an open-ended quantitative easing program. This means that the Fed will be buying mortgage-backed securities at a rate of 40 billion USD per month, not setting any time or volume limit for the purchases.

The statement made it clear to everyone that the Fed’s new stimulus program would operate alongside Operation Twist. Adding up the financial capacity of the two, the central bank will pump in 85 billion USD in liquidity every month until the end of 2012.

The second takeaway from the statement was the Fed’s pledge to keep rates “exceptionally low” until the latter part of 2014 to mid-2015.

Forecast for Q4 2012

It would seem that the Fed has already brought in the big guns. It already has a very loose monetary policy in place. What else can they do in Q4?

Nothing more, it seems. Most market participants predict that we probably won’t see any changes to the Fed’s stance anytime soon even if the economy improves.

It will take a lot of positive data to assure Big Ben and his buddies that the economy is on the road of sustainable growth before they can withdraw their stimulus programs.

European Central Bank (ECB)

European Central Bank
Current Stimulus Program Outright Monetary Transactions (OMT)
Minimum Bid Rate 0.75%

Just like the Fed, the ECB also had performed its own stimulus magic on the markets. Roughly two months ago, ECB President Mario Draghi announced the implementation of Outright Monetary Transactions, or OMT, that aims to fix the region’s “distorted bond markets.”

The OMT will buy bonds with maturities between 1-3 years from debt-troubled euro zone nations to help bring down the yields. It will be made available for those countries that had already requested assistance from the European Financial Stability Facility (EFSF) or the European Stability Mechanism (ESM) rescue funds, or those who will in the future (under some strict conditions, of course).

Unlike the Fed’s quantitative easing program, the OMT purchases will be sterilized, which means no new money will be created.

Forecast for Q4 2012

The ECB’s OMT is still at its early stages, so the effects have yet to be felt. It is what happens a few months down the road that will determine what the ECB will do next. That being said, I think it’s more than reasonable to say that the ECB is done in terms of stimulus programs.

With respect to interest rates, however, there is still some wiggle room. Many economists, including me, see the ECB cutting rates by 50 basis points to 0.50% before the year ends.

Nothing is certain

At the end of the day, predictions are merely predictions, and nothing is set in stone. Always remember to be diligent in your own research and use forecasts as a guide rather than a magic crystal ball. If you have your own guesses, feel free to let me know by leaving a comment below!