Forex Flash: US economy approaching escape velocity? – UBS

FXstreet.com (Barcelona) - The Federal Reserve's decision this week did not yield any substantial changes in policy. Although some will interpret this as providing unnecessary stimulus while ignoring economic realities, the Fed is simply redefining (or 'flexibility interpreting') the various definitions of policy tightening: as long as GDP growth is faster than balance growth, conditions are indeed tighter.

This position can be criticized, however the fact that the Fed can already assert one definition where tightening is actually happening and able to keep this trajectory, means it is already quite far along the curve in policy. “This is perhaps the best reflection of the US economy itself approaching 'escape velocity'.” writes Research Analyst Gareth Berry at UBS.

As for the BoE, it is a different matter. If the Fed's balance sheet is expanding faster, then on a relative basis the dollar should be 'debased' more (i.e. more printing) and the GBP/USD should be going up. The ratio had actually been falling sharply for most of last year until QE3, and just at a time when the BoE chose to temporarily end QE as their focus shifted to credit allocation rather than supply. According to Berry, “Price action in the GBP/USD through most of 2012, however, did not really reflect the fact that while Operation Twist was ongoing and US growth was already starting to outperform, the currency pair did not factor in policy differentials.”