QE2 What will the Fed do?

The FT today reported on the potential size and scope of the Federal Reserve’s plans for a further period of the policy of Quantitative Easing (QE) as worries grow about the risk of a “double dip” recession in the US Economy. The Fed are in a difficult position of trying to achieve the correct level of stimulus to have a positive impact on the economy but at the same time ensuring that they do not go too far as such an action might result in a significant rise in inflation. With this background the FOMC will shortly have one of their most important recent meetings. It is clear that they will soon be embarking on a new round of QE which has been nicknamed QE2. The Fed is widely expected to begin with an additional $500bn of asset purchases in the six months to May 2011. The President of the New York Fed has just suggested that this scale of QE would provide the equivalent economic boost as would be provided by a 75 basis points cut in the Fed Funds Rate. Financial markets are already anticipating an announcement of this level of QE by the Fed and they are hoping to see the FOMC signal their intention to act even more aggressively if required at a later stage. The Fed must be careful, however, as there are some serious concerns about the costs and risks of this latest QE2. The general consensus is that the Fed should be cautious doing just enough QE to get inflation heading upwards but that then stop this action. The danger might be that such caution could disappoint financial markets at a time when confidence is already shaky. As you can see the central banks face an uphill struggle trying to keep everyone happy!