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VOL. 36 | NO. 30 | Friday, July 27, 2012

Will central banks rescue US, European economies?

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WASHINGTON (AP) — The world's top central bankers have said they're willing to rescue the economies of Europe and the United States. This week we'll find out if they are ready to act.

The Federal Reserve wraps up its two-day policy meeting Wednesday. Chairman Ben Bernanke has pledged to act if unemployment stays high. The European Central Bank meets Thursday — a week after ECB President Mario Draghi vowed to "do whatever it takes" to save the European common currency, the euro.

"If the ECB comes through and follows up with what Mr. Draghi said a couple of days ago, that's big," says Nariman Behravesh, chief economist at IHS. "That would minimize the risk of a nasty scenario."

Investors are hoping the Fed and ECB will announce plans to flood markets with cash through large-scale bond purchases. But economists caution that the hopes might be dashed. The Fed might not be in a hurry to act. And investors might be expecting more of Draghi than he can deliver.

Economies on both sides of the Atlantic need help. Unemployment in the 17 countries that use the euro remained at a record 11.2 percent in June, the European Union reported Tuesday. The International Monetary Fund expects the eurozone economy to shrink 0.3 percent this year.

The U.S. government announced last week that the American economy grew at a listless 1.5 percent annual pace from April through June, even slower than the 2 percent rate in the first three months of the year. On Friday, the Labor Department will reveal just how bad the American job market is. Economists expect the unemployment rate remained at 8.2 percent for the third straight month in July and that the economy generated just 100,000 jobs, not enough to keep pace with population growth. The first three months of 2012 job growth averaged more than 225,000 a month.

Still, many economists say the U.S. economy isn't yet weak enough to push the Fed to act now. Some good news dribbled in Tuesday: The Conference Board said consumer confidence rose in July for the first time in five months. The Commerce Department said Americans' incomes grew in June at the fastest pace in three months. And the Standard & Poor's/Case-Shiller home index showed that home prices rose in May from April in every city the index tracks.

Economists say it's more likely the U.S. central bank will wait until its next meeting Sept. 12-13 if they're going to do something. One option, eagerly awaited by financial markets, is a third round of bond purchases designed to push down long-term interest rates, a policy known as "quantitative easing" or QE3. Diane Swonk, chief economist at Mesirow Financial, predicts that the Fed "will stimulate further, but probably not pull the trigger on QE3 until September."

Economists worry that Fed action won't make much difference anyway: Long-term rates are already at historic lows but haven't done much to spur consumer spending.

The Commerce Department reported Tuesday that consumers spent no more in June than they did in May — bad news for an economy that relies on consumer spending for 70 percent of output.

But Americans' incomes and savings rose in June, possibly laying the groundwork for more spending and perhaps stronger economic growth in coming months. "Overall, this is good news for the future, but it provides little help to the U.S. economy right now," Eugenio Aleman, senior economist at Wells Fargo Securities, said. "Consumers may be able to unload these savings if conditions improve during the holiday season."

The ECB is under even more pressure than the Fed. The 17 countries that use the euro are struggling with deepening recessions.

Investors have been demanding record high interest rates on Spanish government bonds because they're worried Spain will be overwhelmed by the cost of bailing out its troubled banks and regional governments. That has raised fears the country may be the next to seek a bailout from the other eurozone countries, following Ireland, Greece, Portugal and Cyprus. Italy, too, is struggling to control its debts as a stagnant economy pinches tax revenues and drives up spending on unemployment benefits and other social programs. The fear is that the pressure will force struggling countries to abandon the euro, something that would rattle financial markets and rock the global economy.

Last Thursday, Draghi sharply raised expectations for more central bank action when he vowed the ECB would do "whatever it takes" to save the 17-country euro, and that "believe me, it will be enough." Markets jumped on the news, expecting that the bank could soon intervene in bond markets to drive down the borrowing costs for Spain, Italy and other European countries.

But economists worry that Draghi might have spoken too boldly and too soon.

The ECB's founding treaty requires the central bank to fight inflation first and only then to pursue other goals, such as stimulating economic growth. By contrast, other central banks, such as the U.S. Federal Reserve and the Bank of England, have broader crisis-fighting powers.

Jonathan Loynes, chief European economist at Capital Economics in London, says Draghi's remarks last week were a "pretty strong signal" the bank might intervene in government bond markets with limited purchases aimed at lowering countries' borrowing costs, as it has before on a limited basis. Markets, however, appear to hope for that plus more, a comprehensive new approach.

"My guess is, the markets will be disappointed," Loynes said.

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