Analysis: Easy Fed softens fiscal policy punch on economy

By Lucia Mutikani

WASHINGTON (Reuters) - The Federal Reserve's aggressive easing of monetary policy is proving surprisingly effective at blunting the blow to the U.S. economy from tighter fiscal policy, according to economists who have been scrambling to raise their growth forecasts.

Economists had feared higher taxes and deep government spending cuts would stunt growth in the first quarter, but a string of strong economic data has so far proven them wrong. And they mostly blame the Fed.

"Monetary policy is beginning to gain some traction here," said Tom Higgins, global macro strategist at Standish Mellon Asset Management in Boston.

According to Higgins, if it were not for the monetary stimulus, the economy would probably be facing growth of a 1 percent annual rate or less. As it is, he expects growth to come in at a 2.5 percent pace in the first quarter.

The U.S. central bank has held overnight interest rates near zero since December 2008 and has pumped about $2.5 trillion into the economy by purchasing Treasury debt and mortgage-backed bonds in a bid to foster faster growth and lower unemployment.

On Wednesday, it recommitted to plans to buy $85 billion worth of bonds each month and said it would keep buying assets until it sees a significant improvement in the labor market.

Those actions have helped put the economy in better shape to deal with the end of a 2 percent payroll tax cut, higher tax rates for wealthy Americans and $85 billion in across-the-board government spending cuts known as the "sequester."

The easy money stance has given a boost to interest rate sensitive sectors of the economy, such as autos and housing.

The commitment to easy policy also appears to be lifting business confidence, which in turn is underpinning job growth and the stock market. Nonfarm payrolls increased 236,000 in February and the jobless rate fell to a four-year low of 7.7 percent.

"The message from the data is that in the battle between fiscal drag and monetary stimulus, the Fed is winning," said Jim O'Sullivan, chief U.S. economist at High Frequency Economics in Valhalla, New York.

Stunned by a surprisingly strong report on retail sales last week, most economists rushed to raise first-quarter growth estimates. JPMorgan pushed theirs up by an eye-catching eight-tenths of a percentage point to 2.3 percent, while Goldman Sachs increased theirs by three-tenths of a point to 2.9 percent.

Economic activity expanded at a meager 0.1 percent rate in the last three months of last year, the slowest pace since the first quarter of 2011.

MADE A MISTAKE

Economists also said they had been mistaken to believe that businesses would retrench if it became clear deep government spending cuts were going to take hold.

They said they had simply been drawing on lessons learned during the acrimonious fight in 2011 to raise the government's borrowing limit, a battle that hit confidence hard.

"The chance we decided to take was for a more upfront impact from sequestration; in reality that is not what we are seeing," said Adolfo Laurenti, deputy chief economist, Mesirow Financial in Chicago. "Businesses have taken it at a more leisurely pace."

Indeed, a Deloitte Growth Enterprise Services survey of about 1,000 mid-market executives this month found little evidence the spending cuts were worrying businesses.

About 72 percent of respondents said sequestration would not affect their businesses and 91 percent said they had not put off hiring because of the cuts. That could be an indication of the confidence generated by the Fed's willingness to aid the economy, economists say.

Also helping the economy is the fact that banks are starting to ease lending standards and household balance sheets have improved after being ravaged by the housing market's collapse.

"What we have been seeing for a while is households have worked down their debt loads and they are now starting to expand their borrowing and, across the board, bank lending is increasing," said Steve Cunningham, head of research at the American Institute for Economic Research in Great Barrington, Massachusetts.

"So monetary policy is becoming effective in that respect."

Fed data this month showed household debt in the fourth quarter grew at its fastest pace since early 2008, while a measure of the burden of carrying debt sank to a record low.

In addition, consumer credit has increased solidly from last year through January of this year and banks in January reported stronger loan demand and easier credit standards.

Still, the economy is not out of the woods by any means.

Part of the expected bounce back in growth this quarter will come from a buildup in business inventories, which means second quarter growth could fall short of the January-March rate.

As a result of the economy's firmer underlying strength, many analysts now estimate government budget cuts could shave off about 0.3 percentage point from GDP this year, half of what was predicted by the nonpartisan Congressional Budget Office.

"The drag from sequestration is probably a little bit smaller than we thought a month ago," said Mesirow Financial's Laurenti. "We have a better economy that is in a better position to absorb a negative shock."

(Reporting by Lucia Mutikani; Editing by Tim Ahmann and Phil Berlowitz)

Source: http://news.yahoo.com/analysis-easy-fed-softens-fiscal-policy-punch-economy-050407739--business.html

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