Bob Baur
Principal Global Investors’ Chief Global Economist, Bob Baur, Ph.D., delves into the July meeting minutes from the Fed and ECB.
Inflation, interest rates, and monetary policy
“Officials at both the U.S. and Eurozone central banks are concerned that recent inflation reports have been weak. But, both banks appear resolute in their desires to reduce monetary accommodation, according to July meeting minutes. The policy statement of the July Federal Open Market Committee (FOMC) meeting noted near-term risks were roughly balanced, ‘but the FOMC is monitoring inflation developments closely.’ Members explored many reasons why low inflation and low unemployment might coexist, as well as whether that coincidence could persist.”
Why weak inflation?
“The FOMC reached a few conclusions, some of which seem contradictory. First, the U.S. expansion will likely continue for some time, but the amount of excess capacity around the world is a formidable obstacle to higher prices. Further, cyclical forces may be boosting U.S. wages faster than traditional measures, as average hourly earnings currently reflect. But, robust household spending, lower saving rates, and more borrowing all suggest wage gains are faster, which have led to higher inflation in the past. The FOMC recognised that rapidly advancing technology can lower prices in specific industries. Still, despite gains from technology, overall prices tend to rise during expansions, and this robust cycle will surely result in more inflation than in the past.”
Does policy change?
“Likely not. Our outlook on FOMC action hasn’t changed. We expect the start date to be announced in September and the bond runoff to begin in October. Likely only a sudden slowdown in growth would derail that timing. The next rate hike will probably be in December or March. That decision will be guided by financial market reaction to the Fed’s bond portfolio reduction, as well as the speed with which inflation begins to edge up toward the Fed’s target.
Euroland policy
“A similar debate occurred at the European Central Bank (ECB). The euro has appreciated significantly and tightened financial conditions. Minutes of the July ECB meeting referenced concerns about possible currency overshooting. Inflation has also been lower than expected in the Eurozone, a second reason to keep policy easy. But, as at the Fed, ECB officials seem set on restricting policy if growth stays robust.”
An energiser bunny: the upturn keeps going
“We’ve been touting the synchronised world economic upturn for several months. Even in the face of legacy skepticism because of the financial crisis, it keeps getting better. Looking ahead, the global expansion beginning in March 2016 has likely hit peak momentum with the surprise improvement in the Eurozone and Japan. Barring military problems with North Korea, trade hitches with China, or political obstructions in the United States, global growth could remain quite robust for several quarters. Financial conditions remain tranquil, inflation and interest rates are low, wages are rising, and job growth is good. Signs of the next recession are nonexistent.”