Focus shifts to Fed as the calmest central bank

• Federal Reserve meeting will not see policy shift, language still key

• UK GDP disappoints in Q4, services sector does all the legwork
  

• Similar language to December will likely keep the USD strong

• Australian inflation beats estimates, market prices out rate cuts

Good morning,

With few developments out of Greece in the past 24 hours, focus has rightly shifted on to today’s Federal Reserve meeting, a meeting which comes at a strange time for central banks. 2015 has so far been a year of volatile policy decisions by these supposed arbiters of monetary policy stability. Central banking is not meant to be sexy, and rarely should it be front page news, but the shift in policy that has become the touchy-feely, ‘forward guidance’ modern way of doing things has ensured that these decisions are not solely covered by the business pages.

Moves by the Swiss National Bank, Bank of Canada and the European Central Bank have all shocked the markets in their individual ways and markets are carefully crouched waiting for some form of curve ball from the boys and girls of the Federal Reserve later today.

The economic environment that we inhabit at the moment is one of uncertain growth, weak and falling inflation measures and low capital investment from business. This is hardly the stage that we would expect to see interest rate increases wheeled out upon by the world’s most important central bank. There is certainly the chance today that the Federal Reserve will ease off the accelerator by at least acknowledging the slowing of the global economy.

That being said, we can expect language around the Fed remaining “patient” on rate increases. Last month’s meeting saw the Fed’s latest inflation expectations for the US economy fall – with a range of 1.0%-1.6% from 1.6%-1.9% at the previous press conference – but we know that core inflation, prices minus food and oil, has been strong. The monetary policy game is all about inflation expectations in the United States. If they are rising then the Fed will feel a lot happier about talking up and eventually pulling the lever on interest rate increases.

We can also expect some comment on the European Central Bank’s latest policy manoeuvre. The Fed will be worried about the US economy importing disinflation from abroad. The ECB’s plan is obviously designed to try and stimulate inflation in the European economy. QE also brings bond yields lower, allowing credit to become cheaper globally and stoking borrowing for businesses and consumers in the US.

The Federal Reserve meeting is due at 7pm GMT.

Yesterday’s GDP announcement saw that growth in the UK has transitioned from exceptional through to solid through 2014, printing at 0.6% through Q4. Construction and mining growth was “erratic” according to the ONS, which must mean that the UK services sector is doing all the growing. 2014 was another year for which a rebalancing of the economy remained elusive.

The headwinds to growth are fairly obvious. As we pointed out yesterday, stumbling growth in the Eurozone and China in recent months has damaged flows with two of our largest trade partners while business investment remains on the side lines as the uncertainty over the General Election and the UK’s relationship with the EU continues. Consumers are seeing disposable income increase but seem more likely to squirrel away anything left over at the end of the month as opposed to spending it. We can blame fears over the unemployment picture and the slow improvement in real wages for this.

Policymakers at the Bank of England are counting on stronger growth to provide the kindling for a firing of inflation pressures within the UK economy. At the moment that kindling seems to be rather damp.

Sterling remained stable after the announcement, gaining against the USD over the course of the session following a poor US durable goods order number.

The main mover overnight has been the Australian dollar, which has run higher on a higher than expected inflation number. CPI as measured by the trimmed mean gauge – one of the RBA’s preferred measures – ran higher to 0.7% on the quarter. Given what has been going on in other inflation markets recently, that is a significant turn up for the books and lessens the near term chance of a rate cut by the RBA at its meeting next week. OIS swaps markets had the probability of a rate cut at the RBA’s meeting on Feb 3rd at a 50/50 chance roughly. Markets now see an 18.6% chance of a decrease in interest rates. AUD is up 0.9% against the USD and 1.1% against the pound.

Have a great day.