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FOMC May 9th Meeting

Thu, May 10 2007, 08:04 GMT
by Javier Amador

BBVA Bancomer

• Fed held the fed funds rate steady at 5.25%; made minor changes to the policy statement
• The wording remains hawkish: reiterated that inflation is the predominant policy concern

Statement retains hawkish bias; signals that the Fed will remain on hold for several meetings

The FOMC kept the fed funds rate steady at 5.25% for the seventh consecutive meeting. As we anticipated, there were changes in the paragraphs on growth and inflation; but more importantly, and also as we expected, the policy paragraph was untouched. The paragraph on growth was changed to allow for weaker data, the first part that previously stated “recent indicators have been mixed” changed to “economic growth slowed in the first part of this year”, thus acknowledging that the economy has further slowed. The statement continued to describe the housing sector adjustment as “ongoing”, while it repeated its characterization of the outlook: “the economy seems likely to expand at a moderate pace over coming quarters”.

With respect to inflation, the statement changed the wording from “recent readings on core inflation have been somewhat elevated” to “core inflation remains somewhat elevated”, implicitly acknowledging the more benign core inflation readings in March, but at the same time indicating the Fed will be very cautious in reacting to inflation until it is convinced that core prices are decisively on a downward trend. As we anticipated, the tone of the paragraph was practically unchanged as it repeated that “although inflation pressures seem likely to moderate over time, the high level of resource utilization has the potential to sustain those pressures”, clearly signaling that the Fed remains vigilant on inflation, as risks remain tilted to the upside. Although we thought that “there was a slight chance of a mild rebalance of risks” (see May 4th Fedwatch), as we expected, the policy paragraph was left intact and retained that the “predominant policy concern remains the risk that inflation will fail to moderate as expected”. In addition, it repeated that “further policy adjustments will depend on the outlook for both inflation and economic growth”, thus, retaining the flexibility for future policy meetings.

Bottom line: we judge that the statement remains consistent with an extended pause as the hawkish bias was not toned down in a context of a low Q107 GDP reading and the recent moderation in core prices. Therefore, the probability of policy easing in the coming meetings decreased, while that of an extended pause –our base scenario– increased. With continued risks to inflation, the statement’s flexibility remains consistent with an extended pause.

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Published on  Thu, May 10 2007, 08:04 GMT