The Federal Open Market Committee (FOMC) today changed its forward guidance to indicate it can be patient in continuing to normalise monetary policy. While it’s a shift in language they were at pains to insist that this is not a change in policy with the Committee seeing the change in language as consistent with its previous guidance and therefore not indicating an earlier than previously communicated increase in interest rates.
It was always going to be the case that at
some point the Committee would be closer to rate hikes than the continued use
of “considerable time” warranted. Recent
data has certainly been supportive of further progress towards policy normalisation
being appropriate including jobs growth (payrolls), average hourly earnings and
The potential fly in the ointment for the
Committee today was recent offshore developments including financial instability
in Russia and sharply lower oil prices.
The Committee, rightly in my opinion, chose to stay focused on domestic
growth and inflation considerations.
But in a nod to the lower oil prices the
language around inflation was tweaked.
Out from the October statement was “the Committee judges that the
likelihood of inflation running persistently below 2% has diminished somewhat
since early this year” while included was “the Committee continues to monitor
inflation developments closely”.
In the press conference Janet Yellen agreed
with us (and, to be fair, the consensus view) that oil price falls will be a
net positive for the US economy and that the inflation impact, while
acknowledging the possibility of some spillover into core inflation, will prove
to be transitory. I agree, although I
still think a significant spillover into core inflation may buy the Committee
some time before hiking. The Summary of
Economic Projections shows lower than expected headline inflation in 2015 while
core inflation is only slightly lower.
The statement also acknowledges further falls
in inflation expectations, but point out that longer-term inflation
expectations have remained stable.
Inflation expectations are important in determining the appropriate
stance of monetary conditions but why expectations shift is just as important –
they can also be due to factors that ultimately prove to be transitory.
The crux of the matter remains that
underutilisation of labour resources continues to diminish and the Committee
therefore expects inflation to rise gradually toward 2% as the labour market
improves further. Interest rate increases are coming. I still think mid next year for the start of
rate hikes with recent (domestic US) data suggesting risks around that timing
are back to evenly balanced (rather than biased to later).