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FOMC to keep fed funds rate stable

Mon, May 7 2007, 14:36 GMT
by BHF-Bank Economics Department

BHF-Bank

• FOMC to keep fed funds rate stable; emphasis on possible moderation of inflation pressures
• Trade balance will have deteriorated in March
• Energy prices will again have had a marked impact on April inflation data
• Retail sales ex gasoline will probably only have risen moderately in April

On Wednesday, the FOMC is very likely to leave the fed funds rate stable at 5.25%, where it has been since the end of June 2006. Monetary policy makers will probably state again that recent indicators have been mixed and that the weakness in the housing sector is by no means over yet. But all in all, the committee will probably stick to its forecast that the economy is likely to continue to expand at a moderate pace over coming quarters. As the core PCE deflator remained unchanged in March and its annual rate declined to 2.1%, the committee might omit the phrase that recent readings on core inflation have been somewhat elevated. They could perhaps merely state that, despite some risks from high utilization rates, inflation pressures are likely to moderate over time, particularly since growth in unit labour costs slowed considerably in Q1 (0.6% qoq and 1.3% yoy after 6.2% qoq and 3.4% yoy).

The February trade deficit narrowed slightly by 0.44bn to 58.44bn, as both exports and imports had fallen markedly. According to the GDP figures for Q1, exports may have gone up moderately in March, while imports could have risen sharply, which is also indicated by the increase in import prices of 1.7% mom. Higher energy prices may have played a major role in widening the deficit, whereas – according to Chinese figures – the trade deficit with China seems to have narrowed. We expect the March trade deficit to have risen to about $61.0bn. However, this would still be significantly lower than the record deficit of $68.9bn registered in August 2006.

Import prices had already increased sharply by 1.7% mom in March, but due to the ongoing increase in oil prices, we expect them to have risen by a further 1.2% mom in April. However, due to a base effect, the annual rate could neverthless decline from 2.8% to below 2%. Import prices ex petroleum, which rose by 0.3% mom in March, could have increased by a similar rate, partly because of higher natural gas prices.

While overall producer prices (PPI) went up sharply by 1.0% mom in March, core PPI remained unchanged. Energy prices will have continued to have a noticeable impact on PPI in April, but food prices might have developed more moderately after three consecutive sharp increases of about 1.5% mom on average. Bearing in mind the recent updrift in import prices and the significantly higher ISM prices component, we expect overall PPI to have risen by 0.6% mom and core PPI to have gone up by a more trend-like 0.2% mom in April. The annual rates may not differ much from their levels in the previous month.

Initial jobless claims fell again quite strongly in the week ending 28 April, by 21k to only 305k. However, this may still be connected with the weather conditions, as cold temperatures and snow storms boosted jobless claims at the beginning of April. The 4-week moving average only fluctuated between 323k and 333k in April, which seems to describe labour market conditions more accurately. However, as the seasonal adjustment might foresee a sharp rise in claims connected with a government shutdown in Puerto Rico in the previous year, jobless claims could either have remained at the low level of 305k in the week ending 5 May, or even have fallen slightly.

According to the Congressional Budget Office (CBO), April’s budget is likely to show a surplus of $176bn, $57bn more than the surplus recorded in the same month last year. Outlays seem to have been moderately higher, but revenues will have increased by a whopping 30%. However, calendar effects explains two thirds of that improvement. All in all, the budget deficit in the first seven months of the current fiscal year would reach a mere $83bn – $101bn less than in the same period last year.

Retail sales rose by 0.7% mom in March, which was more than expected. However, as consumer confidence declined considerably at the beginning of spring, we forecast that growth in retail sales will have slowed to 0.4% mom in April, despite a slight improvement in vehicle sales. Moreover, at least half of that increase may once again be due to sales at gasoline stations, as gasoline prices went up again, by almost 10% mom.

According to the Bureau of Economic Analysis, the change in business inventories subtracted 0.3 percentage points from real GDP in Q1. We thus expect March figures to be relatively subdued. We already know that factory inventories only increased by 0.2% mom, and wholesale inventories are expected to have risen by 0.4% mom. Given that retail inventories probably declined, we expect overall business inventories to have risen by 0.2% mom at best in March.

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Published on  Mon, May 7 2007, 14:39 GMT