USA:
FOMC minutes highlight controversial discussion and underline the close call of not raising the fed funds rate last month
Evidence that r* is likely to remain low for some time constraining future scope of monetary policy
As recently mentioned (UCM Weekly as of 26th September), the statement of the federal open market committee in September left observers with considerable ambiguity in the wording (saying that the committee decided to wait for further evidence of continued progress although the case for an increase in the fed funds rate had strengthened), unusual dissent among FOMC voters (three members would have preferred to raise the fed funds rate) and downward revision of the FOMC’s median rate projections (the longer-run neutral rate projection tipping below 3 % for the first time, Figure 1).
The minutes of the FOMC – released last week – were supposed to shed some light on the uncertainty surrounding the statement. According to the minutes, FOMC participants generally expected that, with gradual adjustments in the stance of monetary policy, economic activity would expand at a moderate pace and labor market conditions would strengthen somewhat further. A substantial majority viewed the near-term risks to the economic outlook as roughly balanced, with several of them indicating that the risks from Brexit had receded. Several participants commented on factors that might be expected to restrain increases in inflation. Such factors included the limited evidence of rising cost or price pressures, the apparent low responsiveness of inflation to the rate of labor utilization, a possible shift in inflation expectations, and remaining economic slack. Many participants observed that core CPI inflation had been running appreciably above core PCE inflation; it was noted that different weights on rents and medical prices as well as different measurement of health-care inflation in the two indexes largely accounted for the disparity.
A number of participants noted that they expected the unemployment rate to run somewhat below its longer-run normal rate and saw a firming of monetary policy over the next few years as likely to be appropriate. A few participants expressed concern that the protracted period of very low interest rates might be encouraging excessive borrowing and increased leverage in the nonfinancial corporate sector.
FOMC discussion on r*: Interest rates lower for long
Participants discussed reasons for the apparent fall over recent years in the neutral real rate of interest (or r*) including lower productivity growth, demographic shifts, and an excess of saving around the world. One participant pointed to a growing consensus that the long period of slow productivity growth and recent evidence that the neutral rate had fallen across countries suggested that r* was likely to remain low for some time. The implications of a fall in longer-run r* would include the possibility that policy interest rates might be closer to the effective lower bound more frequently and for a long period. At the effective lower bound of policy interest rates conventional monetary policy becomes ineffective implying more frequent periods of unconventional monetary policy measures including large-scale asset purchases by the central bank.
Do the FOMC minutes imply a December hike?
Participants generally agreed that the case for increasing the target range for the federal funds rate had strengthened in recent months. Many of them, however, expressed the view that recent evidence suggested that some slack remained in the labor market. With inflation continuing to run below the committee’s 2 % objective and few signs of increased pressure on wages and prices, most of these participants thought it would be appropriate to await further evidence of continued progress towards the committee’s statutory objectives. Some FOMC members were concerned that a further delay would unduly increase the risk of a rapid removal of monetary policy accommodation later on that would eventually shorten the expansion. Several participants also mentioned the risk that the committee’s credibility could be eroded by further delaying the policy rate hike.
Finally, it was noted that it was a close call to leave the target rate of the fed funds rate unchanged. A clear communication to the public of the conditions that would warrant an increase in the policy rate was also called for. Given the outlook (and balanced risks to it) and both the statement that the case for a rate hike has increased in recent months as well as the notice of a close call (of not hiking) in September seem to suggest a high probability of a fed funds rate hike in December.
Eurozone
• Business cycle prospects improved amid positive data surprises
Eurozone industrial production bounced back in August (1.6 % m/m and 1.8 % y/y) following a slump in July (-1.1 % m/m and -0.5 % y/y). The release was a reassuring sign contrary to expectations that the Euro Area business cycle has been slowing down during the second half of the year. The surprising rebound in the industry was in also line with encouraging sentiment indicators in September (PMI, ifo, ESI). Those indicators suggest that GDP growth might print around 0.3 % (q/q) in Q3 2016. Euro Area construction output had recovered in July expanding by 3.1 % (y/y) after 0.6 % in June. On the other hand, annual retail sales growth slowed from 1.8 % to 0.6 % in August (Figure 2).
CEE
• Inflation round-up
In Central and Eastern Europe, inflation has mostly been historically low; trending down elsewhere and some countries have been exhibiting deflation. The subdued consumer price trends were caused by the fall in energy prices during the last year, price and monetary spill-overs from the Euro Area (one of the largest trading partners for a lot of economies) and negative output gaps. In the Central European region, headline inflation has mostly past its troughs reflecting base effects following the decline in energy prices a year ago. In September, deflation eased in Poland (from -0.8 % to -0.5 % y/y) and in Slovakia (from -0.9 % to -0.5 % y/y). Consumer prices increased in Hungary (0.6 % y/y) after several months of deflation. In the Czech Republic, inflation printed at 0.5 % in September.
In Ukraine, inflation made a roller-coaster peaking at 60.9 % (y/y) in April 2015 and returning to 7.9 % last month indicating monetary stabilization and room for the central bank (NBU) to continue cutting the key policy rate (from 15 %). In Russia, the inflation rate kept falling to 6.9 % (y/y) in September from a peak at almost 17 % in March 2015. Last month, the Russian central bank (CBR) had lowered the main policy rate from 10.5 % to 10.0 %. In adopting an inflation-targeting framework, the CBR is keen to bring down inflation to its new target at 4 % in the medium term and, hence, has cautiously been lowering the policy rate and will continue to do so. Romania has deflation since mid-2015 (-0.6 % y/y in September) driven by massive VAT rate cuts (Figure 3).
Also, in South Eastern Europe, Bulgaria and Croatia face deflation (-0.6 % and -0.9 % y/y), while Serbia’s inflation rate has been oscillating around an all-time low (0.6 % y/y in September).