FOMC uncertain about temporary nature slowdown
- Fed fund target rate kept at 0 to 0.25% and still expects that conditions warrant low rates for an extended period of time.
- QE-2 will be completed by end June, QE-3 not excluded but bar is high.
- Recovery is continuing, but more slowly than anticipated; pick up in pace expected though.
- Inflation picked up, but is expected to moderate, inflation expectations stable.
- Growth forecasts revised lower in 2011 and 2012, showing some uncertainty about the temporary nature of the slower growth pace
- Conclusion: Fed stands put for longer, but maybe not longer than the market discounts now.
As expected, the FOMC kept its policy essentially unchanged. A weaker economy and higher inflation is seen as only temporary and thus the FOMC leaves policy unchanged. Fed Fund rate remains at 0- to-0.25%, keeps the language that it expects economic conditions to warrant exceptional low levels for FF rates for an extended period. The programme of asset purchases will be completed at the end of the month, but the Fed maintains its policy of reinvesting proceeds of maturing assets. The FOMC statement doesn’t mention heightened financial risks (linked to Greece) nor (understandable) fiscal issues. It doesn’t talk about its exit policy either. Bernanke admitted uncertainty about the nature of the slowdown puts the bar for QE-3 high and suggests under which circumstances it might be implemented.
More sober on the recovery...
The paragraph on the economic activity was substantially amended, but the essence notably that “the economic recovery is continuing at a moderate pace” was kept unchanged. Household spending and investment in equipment and software continued to expand, investment in non-residential structures is still weak and the housing sector continues to be depressed all indentical wordings when compared to the April FOMC statement.
However, the FOMC recognized that the moderate pace of the recovery is “somewhat slower than the Committee had anticipated.” Similarly, “labour market indicators have been weaker than anticipated”.
The slower pace of the recovery, the statement says reflects “in part factors that are likely to be temporary”, notably the dampening effect of higher food and energy prices on spending and chain disruptions linked to the earthquake in Japan. Therefore in paragraph two, the statement said that the Committee expects the pace of recovery to pick up and the unemployment rate to resume its gradual decline. However during the press conference Bernanke clarified that besides temporary factors hindering the recovery there might also be more permanent factors. The downsizing of the growth forecast in both 2011 and 2012 and the upward revision in the unemployment rate illustrate this uncertainty. For 2011, growth is expected between 2.7% and 2.9% down from 3.1% to 3.3% in April and 3.4% to 3.9% in January. For 2012, the forecast sees growth between 3.3% and 3.7% versus 3.5% and 4.2% in April and versus 3.5% and 4.4% in January.
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