Wednesday, January 28, 2015

FOMC sits on its hands | Inflation is now key in the US too

Yesterday was Fed Day in the US, when the Federal Open Market Committee (FOMC) makes its policy statement and determines whether or not core interest rates will be adjusted.

The rate was left unchanged, as expected. The coded language of the statement has been read as indicating that a rise here will not happen before June, at the earliest. This is because the word “patient” was used, which is supposed to mean that at least two more FOMC meetings will have to take place before there is a rise.

Many observers also believe that a rate rise will only be announced at the end of policy meeting at which there is a press conference by the chair, Ms. Yellen (although Ms. Yellen seems to have denied this). There was no press conference at the end of the two-day meeting yesterday. There will be one after the next meeting, in March, but then not again until June.

Nothing is certain. The metrics that the committee take into account are straightforward enough in themselves but complexity is engendered by the way they interact. Thus, while growth in the economy is encouraging, the picture regarding unemployment, and the all-important participation rate, needs to be brought into sharper focus before there is enough confidence to take a step that, given recent history, would now be of momentous import.

Inflation is now key in the US too

The new, big takeaway from yesterday’s statement concerns inflation, or the lack of it. Up to now, the USA monetary authorities have been fairly sanguine about this issue, in marked contrast to their counterparts in the Eurozone, Japan and Britain. The statement said that

“ Market-based measures of inflation compensation have declined substantially in recent months”.

The recent dramatic fall in energy prices, and the possibility that this tendency has not yet worked its way through the US economy, leave room for doubt about the possibility of US inflation reaching back towards the 2% level that the Fed would like. Raising core interest rates would have the effect of further depressing inflation.

Expectations of the timing of rate rises in the USA, and their likely effect on the US dollar exchange rate, remain on a knife-edge.

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