Dollar strengthens on ?taper? talk

The US dollar was the main beneficiary of yesterday’s trading session as the bi-partisan deal struck between Democrats and Republicans on the US Federal budget increased speculation that the Federal Reserve may start to taper its $85 billion a month quantitative easing program as early as next week when they meet to discuss their latest policy move.

Chief Congressional negotiators Senator Patty Murray and Representative Paul Ryan announced yesterday a deal that would set spending at about $1.01 trillion in the current fiscal year. The budget still needs to be passed in both the Senate and the House.

If passed, it will end three years of impasse and fiscal instability in Washington that culminated in October with the first US government shutdown in 17 years.

Michael Gapen from Barclays suggested that if ratified, the agreement will cut the estimated drag from fiscal policy next year in half and “would lead to a modest direct boost to gross domestic product (GDP) and some upside to our forecast of 2.4% for real GDP growth in 2014”. Gapen added that while the deal reduces the potential for further fiscal brinkmanship surrounding the budget, it “does not provide for an increase in the debt ceiling past 7 February nor does it address longer-term structural budget issues”.

Later yesterday, a White House spokesman confirmed that President Obama would sign the deal into law if it is passed by Congress.

UK news was scarce yesterday but was dominated by a speech in New York by Bank of England Governor Mark Carney in which he confirmed that there remains a need to continue to provide economic stimulus until such a time as the economic recovery is firmly embedded.

Carney did however acknowledge that the potential risks facing the UK economy include the possibility that programmes such as the Funding for Lending Scheme (FLS) might stoke house prices too much hence the recent decision by the Bank and the Treasury to re-focus the scheme towards business lending.

Carney did specifically mention for the first time that excessive strength in the pound sterling is in his opinion a major risk to the economy which prompted something of a sell-off in the value of the pound against the majority of the 16 most actively traded currencies in the market.

Carney indicated that “the true recovery is beginning” but added that firms do not yet really seem to believe this as evidenced by their recent decisions on new investments. He also indicated that “the UK recovery will need to be sustained for a period before productivity and real wage gains can resume in earnest.”