January 25, 2015 / 9:43 AM / 2 years ago

All eyes on Fed, Greece after ECB fires bazooka

5 Min Read

The United States Federal Reserve Board building is shown in Washington October 28, 2014.Gary Cameron

PARIS (Reuters) - After the surprises from central banks which rocked markets at the start of the year, the U.S. Federal Reserve will be watched as closely as ever this week to see that it doesn't stray from its own policy path.

The atmosphere will already be tense as the fallout from Sunday's snap election in Greece settles and concern has grown in some quarters that central banks, which played such a big part in guiding economies through the financial crisis, are becoming less predictable.

The shock of the Swiss National Bank abandoning its cornerstone currency cap had yet to fully subside when the European Central Bank said it would flood markets with over a trillion euros, more than expected, to prevent the euro zone from sliding into deflation.

Canada also cut its rate out of the blue and Denmark did so twice to navigate a world of tumbling oil prices and weak growth.

Now, after Europe mostly dominated the start of the year, attention will turn to the Fed's rate-setting meeting on Tuesday and Wednesday for any sign that its resolve to start raising interest rates mid-way through the year could be softening.

Expectations are for the U.S. central bank to stick to its guns despite the turmoil elsewhere, with top Fed officials citing in the past weeks strong U.S. economic momentum and falling unemployment.

But questions have been raised due to weak wage growth and five-year low oil prices that have dragged U.S. consumer prices down to their biggest drop in six years in December and heightened deflation fears in Europe.

"What we will focus on in January’s statement, which could challenge our view about a June lift-off, are any hints of increased concern that very low headline inflation is putting downward pressure on inflation expectations," analysts at BNP Paribas wrote in a note. "Any mention of foreign developments would also be dovish."

In any case, San Francisco Federal Reserve Bank President John Williams said a day after the Swiss central bank stunned markets, and even some policymakers, by lifting the cap on its currency against the euro that the Fed's goal was "to not surprise or disrupt markets."

Central bank policy meetings in countries including Russia, South Africa, Israel, Sweden and Turkey will also try to tackle tumbling oil prices and the aftermath of the ECB's quantitative easing plan, which sent the euro to an eleven-year low.

Having been relied upon throughout the financial crisis to use their firepower to insulate the system from major shocks, central banks will also be poised to deal the outcome of the Greek general election.

Although around 90 percent of Greek debt is now held by official creditors, largely limiting the possible contagion from any fresh instability there, the country whose debt crisis once threatened the euro's survival still carries risks.

"We believe in the efficacy of QE," JP Morgan analyst David Mackie said. "But, for now, we are not lifting our (euro area) GDP forecast in the face of potential new headwinds from political uncertainty in Greece and the much deeper recession in Russia."

After borrowing rates for euro zone countries fell to record lows on Friday, data throughout the week will give more news on the sluggish health of the currency area and the challenge facing the ECB's QE plan.

Friday's January inflation reading will be of particular interest. Analysts polled by Reuters expect a 0.5 percent drop after prices fell by 0.2 percent last month.

December retail sales and fourth quarter GDP reports from Spain and Austria will help fill the picture. Britain will also publish GDP data on Tuesday. In the United States, fourth quarter advance GDP data will be released on Friday.

Another point of focus how low can the euro can go after it fell to as low as $1.1115 on Friday.

"We believe that the 'currency wars' theme is still valid," AXA IM inflation linked bonds fund manager Jonathan Baltora said, pointing to the round of central bank's decisions of the past weeks.

"The euro area stands to be a winner of the currency war over 2015 with a strong ECB quantitative easing program and a weaker euro."

Also in the spotlight will be oil prices. They have more than halved since June but the Brent closed up on Friday at $48.79 a barrel, with the death of Saudi Arabia's King Abdullah adding to uncertainty over the plans of the world's biggest crude exporter.

Reporting by Ingrid Melander; Editing by Toby Chopra

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