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Fed in focus after emerging market mauling

A money changer counts Turkish lira bills at a currency exchange office in Istanbul January 24, 2014. REUTERS/Murad Sezer
A money changer counts Turkish lira bills at a currency exchange office in Istanbul January 24, 2014. REUTERS/Murad Sezer

By Philip Blenkinsop

BRUSSELS (Reuters) - The U.S. Federal Reserve will take center stage in the week ahead with a widely expected cut to its bond-buying stimulus, responding to an improving U.S. economy but also helping fuel a dramatic emerging market sell-off.

Argentina, Turkey and Ukraine felt the full force last week of a global flight from developing world assets as investors grew concerned about slower growth in China and U.S. monetary tightening, as well as the countries' own problems.

Fed policymakers are expected to confirm the tightening trend during their Jan 28-29 meeting, notably also for being Ben Bernanke's last as chairman before vice chair Janet Yellen takes charge.

They are almost certain to make a second $10 billion cut to the bank's monthly purchase of Treasuries and mortgage-backed securities, from $75 billion now to $65 billion.

They are also likely to leave intact their delicately worded promise to keep interest rates low, although sharply falling unemployment has left some to doubt how long into the future that promise will hold.

"The problem is that investors no longer believe the Fed when we hear that proper rate tightening would happen much later in the future," wrote Benoit Anne of Societe Generale.

"Either the Fed will manage to re-establish some credibility on that front, and global emerging markets will probably find some respite in the future, or we are going into a full-blown meltdown," he continued.

Some would argue the meltdown has already begun, with intervention proving ineffective in stemming an exit from emerging equity funds that has totaled almost $4 billion so far this year.

Argentina's peso suffered its largest daily loss last Thursday since the country's 2002 financial crisis as the central bank gave up its battle against the currency's slide after using more than 30 percent of its reserves last year.

The Turkish lira hit a record low on Friday against the dollar, even after the central bank spent an estimated $3 billion trying to prop it up.

Central banks believed to have intervened to defend their currencies on Friday included India, Taiwan and Malaysia. Russia again moved the rouble's trading band after $350 million in hard currency sales.

EURO ZONE DEFLATION?

Across the Atlantic in post-crisis Europe, EU and euro zone finance ministers meet in Brussels, although their gathering is expected to be a monthly stock-taking rather than one with key decisions to make.

Europe's highlight is likely to be Friday's initial estimate for January inflation, a closely watched figure after concerns about deflation prompted the European Central Bank to cut rates in November.

The consensus forecast is for a rise to an annual 0.9 percent this month from 0.8 percent in December.

Germany will offer an indication with its consumer price figures due out on Thursday, the same day U.S. gross domestic product data for the fourth quarter of 2013 is revealed.

"I think it's going to be a week of data that's relatively calming... U.S. GDP numbers coming in pretty strong at about 3 percent and deflation fears in the euro zone perhaps easing a little bit," said ING senior economist James Knightley.

By contrast, Commerzbank believes the downward trend will continue. It forecasts inflation falling to 0.6 percent in February after 0.7 percent in January.

"Euro zone inflation is the big number of the week... January will be an important test of our below-consensus forecast," said chief economist Joerg Kraemer.

Finally, after a burst of credit rating reports for the past three Fridays, the agencies will take a bit of a breather for the next two weeks. Standard & Poor's assessment of Slovakia and Moody's view of the two EU rescue funds are the only assessments due out next week.

CHINESE NEW YEAR

In Asia, the Chinese also takes a break for New Year holidays as the year of the horse takes over from the snake. Business life closes down from Jan 31, with the official reopening on Feb 7, but for many the real day back at work will be Feb 10.

China's flash Markit/HSBC Purchasing Managers' Index (PMI) fell to 49.6 in January, from December's 50.5, suggesting a mild slowdown at the end of 2013 continued into the start of 2014.

The final manufacturing PMI for January is due on Thursday and the official manufacturing PMI is set for release on Saturday.

The latter is expected to show the same negative trend, though the absolute numbers are higher because it polls mainly bigger and state-owned firms who have had an easier time than the smaller private ones that make up most of the HSBC poll.

(Additional reporting by John Standing in Beijing and Marc Jones in London; Editing by Toby Chopra)

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