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First Line of Defense: Hawkish Wording

Thu, Jun 26 2008, 07:29 GMT
by BBVA Bancomer Team

BBVA Bancomer

• • The Fed maintained its target rate at 2%. But the statement was hawkish in tone, in line with recent speeches of Board members
  

• • FOMC is now more concern with risks to inflation than with risks to the growth outlook

• • While we expect a pause in its next meeting August 5th, the Fed will not hesitate to act if inflationary pressures increase further or if inflation expectations continue to deteriorate

Inflationary Risks continue to rise, while growth drags.

The Federal Open Market Committee maintained its target for the federal funds rate at 2% and the pause and the accompanying press release were in line with our expectations. The vote was not unanimous as one of the ten members voted in favor of a rate hike for this meeting, showing a glimpse of the heated debate that probably ensued.

As in recent speeches by Board members, FOMC raised the tone regarding the inflationary threat, reflecting its worries regarding the deterioration of headline inflation and inflation expectations since the last FOMC meeting. A more hawkish statement is an immediate and expected line of action of any Central Bank to try to avoid contagion of inflation expectations.

The Fed’s assessment on growth was more optimistic than in previous meetings, stating that “Although downside risks to growth remain, they appear to have diminished somewhat”. That said, the statement acknowledged that credit tightening still exists and will continue to slow the economy in the future quarters: “Recent information indicates that overall economic activity continues to expand … although (several factors) are likely to weigh on economic growth over the next few quarters.”

The Fed signals the possibility of rate hikes if the inflation outlook continues to deteriorate.

The changes to the wording suggest that FOMC worries on growth have eased significantly. Thus, as in our baseline scenario, the worst pressures on growth may be behind us. In addition, the Fed expects inflationary pressures to yield as commodities and oil prices edge down. However, inflationary pressures continue to mount up and inflation expectations are moving closer to unwelcome levels. Thus, while we still expect the Fed to keep rates stable in the next meeting, the probability of rate hikes in 2H08 has increased substantially.

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Published on  Thu, Jun 26 2008, 07:40 GMT