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FOMC Minutes of August 5th

Thu, Aug 28 2008, 07:31 GMT
by BBVA Bancomer Team

BBVA Bancomer

• * Base scenario includes a slowdown throughout 2008 and relatively high (although temporary) inflation rates
• * Members gave equal weight to growing growth and inflation risks
• * The minutes explicitly mentioned that the Board expects the next interest rate move to be a rate hike. But did not commit to such move anytime soon

The minutes for August’ FOMC meeting reinforced the views we expressed in our last Fed Watch. The Fed has purposely stirred from its July’s message, time when it expressed growing concerns about inflation and diminishing risks to growth. The Fed now continues to foresee a cyclical slowdown, but with growing and equal risks to both inflation and growth.

The Board’s base scenario for 2008 and 2009 is one where activity is sluggish, headline inflation decelerates and core inflation rises temporarily at the end of 2009. The Fed has not been swayed by better than expected growth numbers during the first half of 2008. The full force of the current downturn will be felt in the second half, once the boost from the fiscal stimulus package fades away and demand for US exports weaken. Exports have been an important pillar for growth in 2008 thanks to the depreciation of the dollar, but hereafter the gain in competitiveness will be countered by an expected economic slowdown in the rest of the world.

The Fed acknowledged a high headline inflation rate, but expects this rate to decrease once the price index starts capturing the latest reduction in oil prices. On the other hand, core inflation still has to capture the increase in oil prices observed in the first half of 2008. The Fed expects this to happen by year’s end, and stabilize thereafter.

But the base scenario is not the Fed’s main concern. The Board is very worried about the risks to the outlook, both in the growth and inflation fronts. Risks to growth still come from a fragile financial system trying to recover from the consequences of the subprime crisis. The recent turmoil surrounding Fannie Mae and Freddie Mac were a clear reminder that the storm is not over.

Inflationary risks come in the form of a potential vicious cycle triggered by the breakout of long-term inflation expectations. Expectations have increased and are relatively high. The Board is divided regarding the probability of such risk. On one hand the downturn will stop firms from rising prices. But on the other, some Board members presented anecdotal evidence that firms are starting to raise prices -forced by rising costs- and that consumers are accepting such move. The board did mention that the next interest rate move would probably be a rate hike. We agree with such statement, but do not expect it to materialize until 2009.

FOMC Minutes of Federal Open Market Committee

August 5th, 2008

“Across the advanced foreign economies, information received since the last meeting pointed to subdued growth in the second quarter and increasing inflation pressures. Weak second-quarter data on industrial production and sentiment in the euro area as well as on consumer expenditures and exports in Japan suggested that the first-quarter strength in output growth was not sustained. Conditions worsened considerably in the United Kingdom, with a deepening slump in the housing sector. In all the major advanced foreign economies, rising food and fuel prices continued to drive overall inflation to recent highs, but core measures of inflation generally rose only modestly. Recent indicators for emerging market economies pointed to some slowing of growth in the second quarter. Real GDP growth in China moderated but remained strong. Incoming data suggested further slowing elsewhere in emerging Asia, and second-quarter activity appeared to have remained sluggish in Mexico. Headline inflation rose further in much of the developing world, largely owing to higher food and energy prices, and several countries continued to face upward pressure on core inflation as well.”

“…the federal funds rate unchanged at this meeting was appropriate and would most effectively promote progress toward the Committee's dual objectives of maximum employment and price stability. Most members did not see the current stance of policy as particularly accommodative, given that many households and businesses were facing elevated borrowing costs and reduced credit availability due to the effects of financial market strains as well as macroeconomic risks. Although members generally anticipated that the next policy move would likely be a tightening, the timing and extent of any change in policy stance would depend on evolving economic and financial developments and the implications for the outlook for economic growth and inflation.”

Published on  Thu, Aug 28 2008, 07:36 GMT