Weak inflation is expected to be the key topic when the Federal Reserve opens a two-day monetary policy meeting Tuesday, its first since its historic interest rate rise in December.
Coming less than a week after the European Central Bank signaled it could expand stimulus measures in March if inflation slows further, the Fed is not expected to take any policy action.
With its first interest rate increase in over nine years in place for just six weeks, the Federal Open Market Committee, the Fed’s policy board, will continue to study how it impacts the US and global economies.
But nerve-wracking global market volatility and plunging oil prices should have the US central bankers reviewing the measured confidence they expressed last month after lifting the near-zero benchmark federal funds rate by a quarter point.
Significantly, since the December meeting several Fed officials have made clear they view deflationary pressures as a significant risk despite other signs, like job creation, that point to firm economic growth.
Oil prices fell by nearly 20 percent in the four weeks after the last FOMC meeting, and although Fed officials have said they expect the impact of weak oil prices to be transitory, there is still no clear bottom for the crude market and, in turn, the drag-down on inflation.
So eyes will be on how the FOMC’s policy statement assesses the risks that prices broadly could continue to fall.
“With global equity markets down substantially over the last several weeks, the US dollar reaching new cyclical highs, and a clouded inflation outlook, the FOMC statement should strike a more cautious tone,” said Deutsche Bank US economist Joseph LaVorgna in a client note.
Need a clearer picture
In December the FOMC’s forecast implied four quarter-point rate increases through this year to end with the benchmark federal funds rate around 1.25 percent.
But if inflation remains as weak as it appears, rates could rise much more slowly.
The global outlook has dimmed in recent months, with the greatest concern about slowing growth in China and stalls in other large emerging-market economies such as Brazil and Russia.
Read also: Nuno Fernandes: Is “Emerging Market” China triggering a global financial crisis?
Last week the International Monetary Fund cut its forecast for global economic growth this year to 3.4 percent, an improvement from 3.1 percent in 2015 but still 0.2 percentage point below what it predicted in October.
It projected the United States would grow only 2.6 percent, 0.2 percentage point less than previously expected due to the strong dollar’s hit on US exporters.
US jobs growth was solid in December and unemployment held at a seven-year low of 5.0 percent.
But there were some signs of weakness in consumer spending and industrial spending.
US consumer prices fell last month overall, and core prices, stripping out food and fuel, rose only 0.1 percent. The Fed has kept monetary policy very loose aiming to push inflation up to around 2.0 percent. So far, that target remains elusive.
Last week ECB chief Mario Draghi made clear weak inflation was a policy concern.
He said the ECB was “determined” to do everything in its power to push eurozone inflation back to its similar target of just below 2.0 percent.
“We have the power, willingness and determination to act. There are no limits how far we are willing to deploy our policy instruments within our mandate,” Draghi said.
In Japan, the central bank — which meets on Thursday and Friday — is also reported to be wrestling with deflationary pressures.
Even so, said LaVorgna, with only a few weeks’ extra data to add to the picture, the FOMC is not likely to publicly alter its view of the coming year.
“It is too early for Fed officials to signal greater concern about the growth outlook,” he said.
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Brace for 50bp rate hike, warn economists
By Eugenie du Preez
Cape Town – All eyes will be on the South African Reserve Bank’s (Sarb’s) monetary policy committee (MPC) when it announces the first interest rate decision of the year on Thursday. The general consensus among economists is that the outcome will be a 50 basis-point hike.
“We forecast a larger incremental 50bp (basis-point) rate hike this time, given both an extended breach of the 6% target ceiling in our CPI (consumer price index) outlook and heightened inflation risks (in ZAR and food prices mostly),” said Citi Research on Monday.
“No matter which path the Sarb chooses, we see a total 100bp (basis point) in rate hikes in 2016. To do a 50bp hike now makes sense to us for it gives the MPC more options in March (pause, +25bp or +50bp) which keeps it ahead of the curve.”
Read also: Kganyago’s interest rate dilemma: Slowing growth, rising inflation.
Rand Merchant Bank (RMB) economist John Cairns believes the MPC faces a choice of a 25bp or 50bp hike. “We favour the former, expecting them to stick to the measured pace of normalisation, but with a hawkish statement.”
This is because a 50bp interest rate increase would shore up confidence levels in both the Sarb and the rand, “flattening the interest rate curve”, according to Cairns.
“The rand, admittedly, is usually not very sensitive to rate changes but we should expect an outsized move, either way, given the negative sentiment in the market over the past two months,” said Cairns.
However, RMB’s Deon Kohlmeyer has a different view: “… the market is still seeing a 50bp hike by the Sarb as the most likely outcome despite some of the governor’s comments in Davos which some participants have regarded as perhaps indicating only 25 basis points. We believe the Sarb will continue in a measured fashion and will stick to 25 points this week,” he said on Monday.
Read also:Â Montalto: Weak Rand skews rate outlook. 75/100bp hike possible.
In his preview of the MPC’s meeting, Nomura emerging markets economist Peter Attard Montalto said the Reserve Bank “has been careful in its rhetoric” ahead of the MPC meeting. “On the one hand it wants to show it remains resolute and credible and will hike in response to a shifted outlook, but on the other hand it also wants to contain market perceptions of a large panicked hike.”
He believes the Sarb knows it is into a new rand paradigm after December’s Nenegate shocks, which probably in theory means that higher real rates are necessary as the country’s credit risk rises. Montalto is of the view that a 50bp hike “can be sold as an adjustment to this new environment” while not being a move to support the rand.
“Indeed, the Sarb is eager to show to markets that it is not looking to backstop the ZAR or target levels and so is keen to limit expectations of 75bp or 100bp increases, even if these might be backed by some MPC members,” said Montalto.
Read also: Past Fed rate hikes been good for developing markets – but not this time
He pointed out that food price moves and the rand pose real challenges to the inflation forecast, and now envisages average inflation of 6.5% in 2016 and 6.7% in 2017. Montalto believes the new forecast will lead to inflation being outside the Reserve Bank’s target in the third and fourth quarters. It will revert in the first quarter of 2017, “which would be far too bullish (low) vs our own forecast and would signal an underestimate of the long and lagged impact of higher food prices and the weaker ZAR”.
Said Montalto: “A 75bp or 100bp hike would be a pleasant surprise, but carrying only a 25% probability. We think a 25bp hike would be a policy mistake and would signal it is too worried about growth over inflation and too happy to be behind the curve with serious inflationary pressures building up.
“We assign a 15% probability to a 25bp hike. We attach a 0% likelihood to rates unchanged and therefore a 60% probability to a 50bp hike. We continue to expect rates to enter tight territory of 8.50% by end-Q1 2017 (8.00% end-2016), because of our inflation forecast and the implications that has for expectations and wages.” –Â Fin24
