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FOMC Minutes May 9th Meeting

Thu, May 31 2007, 07:49 GMT
by Rae Anne Dodds

BBVA Bancomer

• Outlook for growth improves for 2008
• Uncertainties for inflation remain elevated
• Fed rates will remain steady at 5.25%

Outside risks to growth diminish while upside risk to inflation remain high

Positive influences within growth outweigh negative risks, causing GDP growth for 2008 to be revised upward. During the previous meeting, the growth rate was given as “a rate a little below that of the economy’s long run potential;” however, May’s meeting saw growth being revised to “increase at a pace broadly in line with potential output in 2008.” This change in position stems mainly from stronger evidence of the adjustment in nonresidential investment being temporary. In addition, the fears of extensive spillover effects from the housing sector diminished significantly. This containment alleviated fears of a severe housing sector adjustment, but it did spur discussion of it lasting “somewhat longer than expected.” Consumption growth rate is expected to moderate with lower household wealth and higher gasoline prices. While “continued advances in employment and incomes, as well as gains in stock prices” were explanations for support, FOMC expects employment in the construction sector to adjust significantly putting downward pressure on payroll. Despite recent favorable readings of core inflation, members consider that “price pressures were not yet viewed as convincingly on a downward trend.” In addition, some doubt whether “small movements in resource utilization were unlikely to have discernible effects on inflation.” Nonetheless, several participants raised their doubts on the level of the labor market tightness given the modest increases in labor compensation.

The possibility of declining productivity was thoroughly discussed signaling the uncertainty of the outlook for both potential GDP and long term inflation. In addition, FOMC discussed concerns about the weakening of the dollar and rising global demand which could potentially spur commodity prices. This signals FOMC’s increased attention on potential inflationary pressures in coming years.

Minutes signal a “wait and see” strategy

We believe the minutes send an implicit warning that even if below trend GDP growth lowers pressures on resources and core inflation eases somewhat they will continue a watchful waiting policy. Therefore, the minutes confirm the FOMC will hold rates at 5.25% for a considerable period of time. The uncertainties on productivity and global inflationary pressures further reduce the probability of monetary policy easing anytime soon.

Discussion on growth: “Members continued to view the risks to economic activity as weighted to the downside, although with turmoil in the subprime market appearing to have remained relatively well contained and business spending indicators suggesting a more encouraging outlook, these downside risks were judged to have diminished slightly.”

Discussion on inflation: “Although readings on core inflation in March had been more favorable, this followed several months of elevated inflation data and price pressures were not yet viewed as convincingly on a downward trend. Most participants expected core inflation to moderate gradually, fostered in part by stable inflation expectations and a likely deceleration in shelter costs. Some participants also expected the anticipated slight easing of pressures on resources to help nudge inflation lower, although others felt that small movements in resource utilization were unlikely to have discernible effects on inflation. All participants agreed that the risks around the anticipated moderation in inflation were to the upside; and some noted that a failure of inflation to moderate could entail significant costs particularly if it led to an upward drift in inflation expectations.”

Discussion on monetary policy: “Recent developments were seen as supporting the Committee's view that maintaining the current target rate was likely to foster moderate economic growth and a gradual ebbing in core inflation. Members continued to view the risks to economic activity as weighted to the downside, although with turmoil in the subprime market appearing to have remained relatively well contained and business spending indicators suggesting a more encouraging outlook, these downside risks were judged to have diminished slightly. Members agreed that considerable uncertainty attended the prospects for inflation, and the risk that inflation would fail to moderate as desired remained the Committee's predominant concern.”

Fed Funds: 5.25%

Next FOMC Meeting: June 27th/28th

Minutes Release: July 19th

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Published on  Thu, May 31 2007, 09:38 GMT