- FOMC takes a first step toward raising interest rates, but suggests slower pace of rate hikes
- Fed officials confident that lower oil prices are only temporary and inflation will move back to target
Fed gets ready for rate hike with “patience”
During the last meeting of the year, FOMC members decided to take a patient approach in beginning to normalise the stance of monetary policy. In doing so the Committee decided not to mention the difficulties in the global economy and they even mentioned that the lower oil prices are seen as transitory, adding that they expect inflation to rise gradually toward its target over time. During the press conference, Chair Yellen clarified that this did not mean an earlier hike than the FOMC had previously communicated. Chair Yellen mentioned that they did not expect a rate hike at least in the next couple of meetings, suggesting that a hike is likely in mid-2015, if inflation moves towards the target.
Pace of normalisation slower and determined by data
Indeed, the statement suggests that inflation is being closely monitored. We think that given the solid labour market recovery, the trigger for the first rate hike will be the gradual increase in inflation towards the 2% target. But there are different views regarding the pace of the rate hikes. Many FOMC members have said that the pace should be data dependent and more likely gradual. In any case there seems to be consensus that rate increases would not follow a pre-determined path. With regards to the dots, the median dot fell by 25bp to 1.125% at the end of 2015, by 37.5bp to 2.5% at end 2016 and by 12.5bp to 3.625% at end 2017. This suggests a milder approach than in September. We expect the Fed to hike rates in mid 2015 and the federal funds rate to rise to 1.0% at year-end 2015 and to 3% at year-end 2016. This means a hike every other meeting starting in June 2015, after which the Fed steps up the pace to a rate hike every meeting until it reaches 3% at year-end 2016.
Unemployment improves and inflation lower for a while
Regarding the Summary of Economic Projections, since the last forecast in September, unemployment has been revised down in the coming two years, reflecting a faster than expected recovery in the labour market, but long term unemployment was unchanged at 5.2%-5.5%. Meanwhile, inflation was adjusted downwards in 2014 and 2015, mainly as a result of lower oil prices. GDP growth was practically unchanged during the forecast period.
Direct effects of Russia on eurozone moderate, but confidence impact a question mark
The Russian authorities managed to strengthen the ruble yesterday following aggressive intervention. However, as noted in yesterday’s Daily, the risk of a severe financial crisis is significant. In any case, a deep recession in Russia looks to be on the cards. So what will be the impact on the eurozone economy?
The direct effects look likely to be moderate given that exports to Russia have already fallen sharply. The share of Russia in total eurozone exports was 3.8% in October. It peaked at 5% at the start of 2013 and has gradually fallen since then. The share of exports to Russia in eurozone GDP is 0.7%. Eurozone exports to Russia are currently declining by 15% yoy, so even if the pace doubles, the impact on GDP would not be much more than a tenth. The direct impact on the German economy would be similar. In addition, the fall in oil prices – a key factor behind Russia’s problems – is a major support to domestic demand in the eurozone. However, a more negative impact might come if Russia’s troubles hurt business confidence. This was the case with regards to the Ukraine crisis, which seemed to weigh on business confidence, especially in Germany. So the survey indicators should be watched closely over the next couple of months.