US Fed: Rates Likely To Stay At 2%, But Don’t Expect The Hawkish Commentary To Stop

The Federal Reserve’s most recent Beige Book report summarized the current economic and financial situation best, as it noted rising price pressures, slowing growth, and tightening credit. However, many individual FOMC members have focused more on the inflation issue. Does this mean the Fed is planning on raising interest rates? No. Given the rapid deterioration in economic expansion and credit conditions, a hike would only exacerbate these problems. However, the Fed will continue to seek to hold down inflation expectations amongst consumers with biased rhetoric, which is usually enough in its own right to strengthen the US dollar.

Federal Reserve’s Beige Book Report

“Reports from the twelve Federal Reserve Districts suggest that the pace of economic activity has slowed somewhat since the last report… All reporting Districts characterized overall price pressures as elevated or increasing…Most Districts reported a further tightening of credit standards, especially for residential real estate and construction loans...Among the Districts that commented on bank loan quality, some deterioration was reported...”

Frederic Mishkin, Federal Reserve Board Governor

“Because of the recent adverse shocks to the economy--including turmoil in financial markets and the sharp increase in the prices of oil--output growth in recent quarters has fallen below potential, and the unemployment rate is, as best as I can judge, above the natural rate. Similarly, sharp increases in the prices of many commodities have driven inflation above rates consistent with price stability.”

Kevin Warsh, Federal Reserve Board Governor

“Financial markets continue to show the ill effects of turmoil triggered by mortgage losses. The real economy is underperforming in terms of growth and job creation, a result in part of financial strains. And financial institutions themselves are affected by the generalized pullback in liquidity and deteriorating credit quality.”

BOE: Where Will The Divided Monetary Policy Committee Go From Here?

There is a clear division in opinion amongst the members of the Bank of England’s Monetary Policy Committee. David Blanchflower remains by far the most dovish, as he has consistently voted in favor of rate cuts. However, with UK CPI accelerating much faster than previously expected, Mr. Blanchflower may have difficulty winning over other undecided voters on board, especially as one member - Tim Besley - voted for a rate hike in July. Nevertheless, it appears that we will have the clearest view of the MPC’s bias following the August policy meeting, as their Inflation Report will be issued at that time.

Bank of England July Meeting Minutes

“Although it could do little to alter the path of inflation in the near term, the Committee could, by raising Bank Rate this month, send a strong signal that it was focused on inflation and remained determined to bring it back to target in the medium term. There was a risk that medium-term inflation expectations might move significantly away from the target. If that were to happen, a more pronounced slowing in activity would be needed to bring inflation back to target.”

“However, there were also a number of arguments for maintaining Bank Rate at 5.0% this month…. An increase in Bank Rate in the current circumstances, when confidence was low and the financial sector fragile, could impart a downward momentum to the economy that risked a significant undershoot of inflation in the medium term. Keeping Bank Rate at 5.0% when the economy was slowing was arguably already sending a strong signal of the MPC’s commitment to reducing inflation. A rate change this month would be a surprise at a time when credit and other financial markets remained fragile, and any change in rates would be better communicated alongside the Bank’s August Inflation Report.”

“For another member, the news on the month had reinforced the case for an immediate reduction in Bank Rate in order to avoid inflation undershooting the target in the medium term. The activity data had been uniformly gloomy and broad-based and activity now seemed likely to contract sharply in the near term, possibly for several quarters. Long-term inflation expectations remained contained and domestically generated inflation remained low. As a result, there was little or no likelihood of a rise in wage growth.”

Charles Bean, Bank of England Deputy Governor

“At the current juncture, there is a marked discrepancy between the official data on the volume of retail spending, which points to considerable robustness this year…though that was fully reversed in today’s release for June - and the CBI Distributive Trades survey, which suggests significant weakness. While the ONS have suggested that the official data are likely to be better…the conformity of the picture given by the Distributive Trades survey with other potential indicators of spending, such as consumer confidence and the Agents reports, have led us to place less weight on the official data on retail spending for the present.”

Richard Lee is a Currency Strategist at FXCM.