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Fed set to taper QE as US picks up

Signs of gathering momentum in world's biggest economy will influence central bank's decision

The US Federal Reserve is poised to mark a turning point for the world's biggest economy this week as rate-setters face a delicate decision over tightening monetary policy for the first time in more than seven years.

The Federal Open Market Committee is expected to announce a slowdown in the pace of its $85bn-a-month (£53.7bn) quantitative easing (QE) programme amid signs of gathering momentum behind the $16trn US economy.

Economists expect outgoing chairman Ben Bernanke to win over committee colleagues to a $10bn tapering of QE, under which the Fed has been buying up $45bn in treasury gilts and $40bn in mortgage-backed bonds since September last year.

Even with interest rates set to remain at close to zero for the near future, the modest scaling back of the stimulus would be the first shift in the direction of policy since the Fed last raised interest rates – to 5.25 per cent in June 2006, more than a year before the credit crunch struck. QE could be wrapped up entirely by the middle of next year under the Fed's timetable.

The sea-change comes against a backdrop of an improving US economy, which expanded at an annual pace of 2.5 per cent between April and June – more than double the speed of the first quarter. Unemployment dropped to 7.3 per cent in August and manufacturing surveys are consistent with annual growth of more than 3 per cent.

But dovish opponents say lower workforce participation is behind a falling jobless rate and stress inflation is still below the Fed's 2 per cent target. Meanwhile, tensions with Syria and another looming row between President Obama and Congress over extending the US debt ceiling add to the uncertainty.

Investec chief economist Philip Shaw said: "An announcement of a taper next week is certainly not a done deal."

US Treasury yields have risen steeply to touch 3 per cent since Mr Bernanke outlined his tapering plans, also pushing up the cost of the UK's long-term debt. The Fed has committed not to raise rates until unemployment drops to 6.5 per cent, but the potential policy shift contrasts with the loose stance of the Bank of England and European Central Bank.

ING Bank economist James Knightley said: "Tapering could be helpful to the UK because it will strengthen the dollar against the pound and boost exports, but there may also be an inflation headache because things like oil are priced in dollars and it could raise import prices."