The Federal Reserve's move to reallocate its bond portfolio is likely to give the U.S. economy a limited boost as the U.S. central bank fell short of taking further monetary easing, market watchers said Thursday.
After a two-day policy meeting, the Fed said on Wednesday that it will sell short-term Treasury bonds worth US$400 billion to purchase the same amount of longer-dated securities in a so-called "operation twist" program, by the end of June next year. The move aims to drive down long-term borrowing costs without further bloating its balance sheet.
Market watchers said that the move, which was widely factored in the market, is likely to have a limited effect in boosting the U.S. economy as yields of longer-dated government bonds are already at a low level.
"The Fed's move to rebalance its portfolio was widely expected and it fell short of containing liquidity injection such as cutting the interest rate that the Fed pays banks on excess reserves," said Kim Yoon-gee, a senior economist at Daishin Economic Research Institute.
"Investors' panicky responses in the market today are mainly due to credit downgrades in U.S. and Italian banks."
Analysts focused on the Fed's assessment of the U.S. economy as the U.S. central bank warned of "significant downside risks to the economic outlook, including strains in global financial markets."
"What the market wanted was more powerful liquidity injection. The U.S. economy will not recover from only lowered borrowing costs," said Oh Suk-tae, an economist at SC First Bank.
Market watchers said the gloomy global economic outlooks and the eurozone debt crisis will further spur demand for safe assets, which will complicate South Korea's fight to contain high inflation.
"The Fed's operation twist will prompt more investors to bet on a fall in long-term yields of U.S. treasury bonds, inviting global capitals into its bond markets and strengthening the dollar," said Park Sang-hyun, a senior economist at HI Investment & Securities Co.
They noted that the Korean currency is likely to further lose ground, dragged by the bleaker outlook for the U.S. economy and the deepening eurozone debt crisis, making it difficult for South Korea to battle with inflation.
The local currency's losses put upward pressure on inflation as it increases import prices.
The global economic outlooks are getting bleaker and Europe's sovereign debt crisis is not showing signs of settling down as credit downgrades in European banks and debt-ridden Italy are raising fears about risk contagions.
The International Monetary Fund (IMF) lowered its outlook for the Korean economy to 4 percent from 4.5 percent while jacking up inflation projection to 4.5 percent from 4.3 percent.
Volatility in the financial markets increased with the Korean currency falling more than 5 percent to the dollar this week alone. The Korean won was trading at 1,176.90 won per dollar, down 27 won from the previous day's close as of 11:08 a.m.
"The won's weakness will put upward pressure on Korea's inflation and throw cold water in the local bond markets. But despite inflation risks, the Bank of Korea (BOK) is not able to raise the key rate for the remainder of this year due to the dimmer global outlooks," said Lee Sung-kwon, an economist at Shinhan Investment Corp.
South Korea's consumer prices jumped a whopping 5.3 percent in August from a year earlier, surpassing the upper ceiling of the BOK's 2-4 percent inflation target band for the eighth straight month.