November 4, 2010 / 9:59 PM / 10 years ago

UPDATE 1-QE2 to intensify emerging mkt inflows-IMF's Blanchard

(Adds details, background)

LONDON, Nov 4 (Reuters) - The second round of economic stimulus unleashed by the U.S. Federal Reserve will intensify capital flows into emerging markets by reducing the carry trade risk, the International Monetary Fund’s chief economist said on Thursday.

The IMF’s Olivier Blanchard said the $600 billion additional quantitative easing (QE) the Fed announced on Wednesday reinforced investors’ belief that U.S. interest rates would remain low for some time.

“The mechnical effects (of QE) may not be that large but the psychological effects may be larger,” Blanchard said at a lecture at the London School of Economics.

“The risk associated with sharp moves in interest rates is largely gone, which makes the carry trade more attractive, and this implies more capital flows outside the United States,” he added.

Ultra-low interest rates in the developed world have driven investors toward higher-yielding emerging markets. They borrow in low-yielding currencies, such as the dollar, to invest in countries with higher-yielding assets.

Those countries’ currencies have hit multiyear highs, hurting their exporters.

Blanchard said it was in the interest of emerging economies to allow their currencies to appreciate in order to boost domestic consumption and reduce their reliance on exports.

But he acknowledged that the scale of short-term capital flows could be destabilising, as they were hard for many of these economies to absorb.

“It makes sense for countries to use capital controls if (inflows) become too much, though there is some question about what the tools should be,” he said.

Blanchard reiterated the IMF’s global growth forecast of 4 to 5 percent for 2011, and said that of European economies, Germany “is pulling ahead of the pack.” (Reporting by Sebastian Tong and Simon Falush; Editing by Dan Grebler)

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