Stephen Foley: It's a guessing game over the US economy

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The Independent Online

US Outlook: Officials at the Federal Reserve sparked a mini-stock market rally midweek when they briefed journalists that a new round of monetary stimulus will be on the agenda of the Federal Open Market Committee when it meets next week.

On the evidence of yesterday's GDP figures for the second quarter, the Fed would be better off keeping its powder dry.

The US economy grew at an annualised rate of 1.5 per cent, sharply lower than the 2.0 per cent of the first part of the year and the 4.1 per cent pace on which we ended 2011, but still not in recessionary territory.

Business spending was better than feared, helping to offset some of the headwinds from spending cuts in local and state government and from a US consumer still trying to pay off debts and worried about their jobs.

The issue for the Fed is not so much that the economy is not weak enough to justify a new round of bond-buying in what is now universally known as QE3 (a third burst of quantitative easing). It is that quantitative easing has diminishing returns, and the central bank ought to conserve ammo just in case a malfunctioning Congress fails to head off the massive, contractionary tax hikes that are due on 1 January.

The central case is that politicians will indeed come together to extend most of the Bush-era tax cuts before they expire, and delay the imposition of spending cuts for the military – but probably not until the last minute.

Between now and then, the uncertainty could weigh down business spending, which is why the world's largest economy could get still worse before it gets better.