Fed's shock taper decision 'damages credibility'

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The US Federal Reserve has damaged its credibility and sown confusion about central banks’ communication strategies by surprising markets with its decision to keep quantitative easing on hold, economists have warned.

The Fed shocked markets across the world by leaving its $85bn-a-month asset purchase scheme unchanged on Wednesday, despite guiding traders to believe that so-called “tapering” would begin this month. Most Fed followers had expected the stimulus programme to be reduced by between $5bn and $15bn a month.

Markets soared on the promise of more stimulus, with the FTSE 100 (FTSE: ^FTSE - news) gaining 1pc to 6,625.39 and the European index, FTSEurofirst 300, hitting a five-year high. UK 10-year gilt yields dipped 10.3 basis points to 2.898pc as gilt prices rose.

But traders were dismayed by the Fed’s confused messaging, which will not help other central banks such as the Bank of England and the European Central Bank that are relying on “forward guidance” to keep monetary policy loose.

David Keeble, head of interest rate strategy at Credit Agricole, said: “Fed credibility and its communication strategy are in tatters.”

Russell Jones, an economist at Llewellyn Consulting, added: “As we understood it, the primary purpose of increased Fed transparency was to clarify what it was likely to do, and why. It was designed to spell out its reaction function and so manage expectations. If so, this strategy has been compromised.”

The abrupt change in stance will “add to market volatility”, Mr Jones claimed, and has injected “a huge element of uncertainty” into markets, Societe Generale strategist Albert Edwards said.

Gerard Lane, equity strategist at Shore Capital, said: “The [Fed] allowed the market to assume September as a tapering date... the surprise decision to stand pat may result in a lower degree of confidence in the policy environment. How will the [Fed] provide forward guidance in the future?”

Markets are now talking about “tapering” beginning in October, Christopher Vecchio, Currency Analyst at DailyFX, said. However, he said December seemed more likely, though others suggested the tightening may not start until the new year.