- FOMC minutes suggest that FOMC is edging towards earlier move, though Yellen remains key
- Decline in oil prices likely to further cap eurozone inflation – low seen at 0.3%
- Latest data suggest that Emerging Europe has so far weathered the ‘Ukraine storm’ relatively well
FOMC minutes had a clearly less dovish tone
The minutes of the FOMC’s July meeting suggest that many members see a risk that interest rates will need to go up earlier than currently anticipated. The minutes recorded that ‘participants generally agreed that both the recent improvement in labor market conditions and the cumulative progress over the past year had been greater than anticipated and that labor market conditions had moved noticeably closer to those viewed as normal in the longer run’. In addition ‘many participants noted that if convergence toward the Committee’s objectives occurred more quickly than expected, it might become appropriate to begin removing monetary policy accommodation sooner than they currently anticipated.’ Following the minutes, financial markets started to price in a higher trajectory for short term interest rates next year, with Treasury yields and the dollar rising, and gold prices falling, as a result. Meanwhile, equity prices trimmed earlier gains. Our central view is that interest rates will likely go up around the middle of next year, which is earlier than financial markets are currently pricing in. However, it remains to be seen to what extent the Fed is already changing its stance. The Fed Chair has tended to dominate the policy of the FOMC in the past, and Janet Yellen is one of the more dovish members. So her speech at Jackson Hole later in the week is the real test.
Oil prices like to cap eurozone inflation at low levels
Eurozone inflation continues to be a major focus of investors given fears of deflation and expectations that the ECB will finally follow other central banks in putting in place QE. Given recent data we have refreshed our eurozone inflation forecast. The recent decline in oil prices will lower the near term profile somewhat. Inflation now looks like falling to a low of 0.3% yoy by September. That should be the bottom with inflation likely to inch only a little higher by the end of the year. Next year we expect inflation to embark on a gradual upward trend. Firmer global goods price inflation, the weaker euro and higher food price inflation are the main factors behind this view. We see inflation averaging 0.5% this year and 1% next year. This is only modestly lower than the ECB’s current projections (0.7% and 1.1%, respectively). As long as core inflation remains stable, the focus of the ECB’s monetary policy is likely to be the economic outlook. In that respect, August’s PMIs for the eurozone (published Thursday) are important.
Emerging Europe so far resilient to Ukraine crisis
Recent data suggest that Emerging Europe has slowed somewhat, but is weathering the ‘Ukraine storm’ relatively well. Our GDP weighted emerging Europe manufacturing PMI, after falling to 49.6 in June, rose to 50.7 in July again, suggesting that the region as a whole has continued to grow moderately. Although the region is exposed to the recent slowing of the eurozone and Germany in particular, trade links between emerging European countries and Ukraine/Russia are modest. In addition, emerging European countries are benefitting from strong domestic cyclical forces that are underpinning consumption and investment growth, a trend that we expect to continue going forward. Another reason why emerging Europe is weathering the Ukraine crisis relatively well is that Russia’s economy, so far, seems to be not too hard hit by the imposed sanctions, though substantial risks remain. Turning to other emerging European economies, the Hungarian economy seems to be the least affected by the Ukraine crisis. In fact, recent data have prompted us to raise our 2014 growth forecast. The weakening in growth in Poland is most likely related to the crisis. However, we doubt that the softening in the Czech Republic and Turkey has much to do with the Ukraine crisis. Indeed, growth in the Czech Republic mostly slowed due to the effects of the excise tax on tobacco that was imposed at the beginning of the year. Meanwhile in Turkey, although the central bank has started to loosen its policy, this still needs to filter through the economy.