The Fed left the federal funds rate unchanged at 5.25% at the close of today’s meeting. The federal funds rate has been held at 5.25% since the June 2006 FOMC meeting.
The surprise was the fact that the FOMC left the focus on inflation intact despite the recent deceleration in core inflation as depicted by the personal consumption expenditure price index excluding food and energy (see chart 2). It is nearly certain there are members on the FOMC who do not see inflation as the “predominant” risk. There are two different opinions about the situation in the labor market. The hawkish opinion sees the upside risk of inflation from the low unemployment rate and the recent decline in jobless claims numbers. The April employment report and the fact that all wage compensation measures are not pointing to tight conditions is the more dovish side of the story. It appears the Fed is erring on the side of caution to maintain credibility as an inflation fighter. The Fed also sees no reason to upset inflation expectations which are well anchored. The Fed needs another weak employment report to be convinced of the underlying weakness in the labor market.
The policy statement indicated that “the economy seems likely to continue to expand at moderate pace over coming quarters.” The U.S. economy grew at a paltry pace of 1.3% in the first quarter. The FOMC’s forecast for 2007 shows a central tendency for economic growth in 2007 is between 2-1/2% and 3.0% growth. After a 1.3% gain in the first quarter, if the FOMC’s forecast is close to accuracy, then growth in the last three quarters of 2007 needs to be stronger than what was predicted in February or the FOMC has revised its forecast (which should be revealed in the minutes of this meeting).
Janet Yellen, President of the San Francisco Fed, remarked on April 26: “My forecast for real GDP growth in all of 2007 is modestly lower than it used to be, and I think my comments should make it clear that there are downside risks to this outcome, since it depends on near-term rebounds in both housing and business investment in equipment.” The minutes of this meeting, to be published on May 30, should reveal a great deal more than what appears in the policy statement.
