QE3 Triggers Higher Inflation Risks Gold Seen Hitting $1850-$1900

By: Ben_Traynor

WHOLESALE MARKET gold bullion prices held above $1770 an ounce for most of Friday morning's London trading, near their six-month highs hit after the US Federal Reserve announced a third round of quantitative easing (QE3) yesterday, leading to warnings that the risk of inflation has risen.

"After the move [gold bullion] had, not just yesterday, but over the last two or three weeks I think it would be natural to look for a period of consolidation," says Credit Suisse analyst Tom Kendall in London.

"But certainly going into the back end of this year, I would be looking for gold to be getting towards at least the $1850 level."

Silver bullion traded around $34.70 an ounce this morning, also close to new six-month highs, as stocks, commodities and the Euro all moved higher after Fed policymakers voted 11-1 in favor of new asset purchases.

"Silver is poised to test the next resistance level at $35.4," one trader in Shanghai tells newswire Reuters. 

"The recent rally, which has lifted silver by about 25% over the past month, is suppressing short-term physical demand"

The Fed announced Thursday that it will purchase $40 billion of mortgage-backed securities per month, and will continue such purchases until the outlook for the labor market improves "substantially".

In addition, the Fed will continue its policy aimed at lowering longer-term US Treasury bond yields, known as Operation Twist, due to run until December. The Fed will also continue its policy of reinvesting principal payments on currently-held mortgage-backed securities back into this asset class.

In its statement, the Federal Open Market Committee said that the combined effect of its actions would amount to around $85 billion of asset purchases per month until the end of 2012.

"This is a Main Street policy, because what we're about here is trying to get jobs going," Fed chairman Ben Bernanke told a press conference following the announcement.

"We're trying to create more employment. We're trying to meet our maximum employment mandate, so that's the objective."

"[Bernanke will] fight and fight until he sees a real improvement in the economy," says Ethan Harris, New York-based co-head of global economics at Bank of America Merrill Lynch.

"He's not going to let his critics stop him. He believes quantitative easing can help the economy and the Fed can avoid inflation, so he'll just keep at it until there's a real turn in the economy."

The latest nonfarm payroll data suggest the US economy added 96,000 jobs in August, below the 150,000-200,000 Bernanke estimated in April is needed to meet Fed unemployment projections.

The US unemployment rate meantime has remained above 8% since February 2009.

"There is not a specific number we have in mind [for unemployment]," Bernanke told reporters.

"But what we've seen in the last six months isn't it."

In addition to announcing asset purchases, Fed policymakers extended their guidance for near-zero interest rates to at least mid-2015, beyond the previous guidance of late 2014.
US Treasury bond prices fell overnight for bonds with maturities of three years or more, pushing longer-dated yields higher.

"[The Fed's decision to leave] purchases open-ended and extending their guidance means a steeper yield curve, as there is more inflation risk," says Societe Generale trader Sean Murphy in New York.

"The need to come out with the operation at all is alerting everyone that there is a long road in this recovery and there are still many things that need to be addressed."

"Controlling the fire of inflation once it is roaring is a difficult task," warns Congressman Kevin Brady, a Republican from Texas and vice chair of the Joint Economic Committee.

"The Fed is overly confident about its ability to pick the right time to withdraw all this stimulus."
Economist Paul Krugman however says that it's "good to see the Fed moving, finally".

Writing in his New York Times column, Krugman adds that "the Fed seems to be trying to 'credibly promise to be irresponsible'" as a way of raising inflation expectations, something Krugman advocated the Bank of Japan do back in the 1990s.

"As [Bernanke] himself said," adds Neal Soss, chief economist at Credit Suisse and a former New York Fed economist, the Fed has built up a lot of capital with respect to inflation credibility...the point of having capital is, from time to time, to spend it."

"Should the Fed expand its balance sheet by a further $1.3 trillion," says Standard Bank strategist Walter de Wet, "it would lift our fair value estimate for gold to around $1900. As a result, even from current levels of gold at $1770, we still see substantial upside for the metal."

Here in Europe meantime, Spain would be "daft" to ask for a bailout on top of the €100 billion it has already agreed to fund banking sector restructuring, according to German finance minister Wolfgang Schaeuble.

"I'm not in the camp that says 'take the money,'" Schaeuble said in an interview Thursday.

"I'm one of those who says we should do everything possible to convince the markets that...speculation against Spain is without any basis in reality."

"Our desire and intention," said Spain's budget minister Cristobal Montoro yesterday, "is to return again to being a reliable partner in Europe that doesn't ask for anything."

On the currency markets, the Euro rallied above $1.31 against the Dollar for the first time since early May this morning. Despite this strengthening, Euro gold bullion prices set a record high at Friday morning's London Fix above €1359 per ounce, before drifting lower towards lunchtime.

By Ben Traynor
BullionVault.com

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Editor of Gold News, the analysis and investment research site from world-leading gold ownership service BullionVault, Ben Traynor was formerly editor of the Fleet Street Letter, the UK's longest-running investment letter. A Cambridge economics graduate, he is a professional writer and editor with a specialist interest in monetary economics.(c) BullionVault 2012

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