Global Daily – Yellen prepares for rate hike

by: Maritza Cabezas , Aline Schuiling

Global-Daily-Insight-25-February-2015.pdf ()
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  • Fed Chair Yellen confident on economy, labour market and inflation…
  • … prepares public and financial markets for rate hike, but leaves room for flexibility
  • Approval of Greece’s reform plans is a crucial step, but tough negotiations still lie ahead

 

Recovery on firm footing, but some challenges remain

Although the testimony started on a positive tone, it gradually became more cautious.  Fed Chair Yellen mentioned that the employment situation has been improving among many dimensions, but cited that the participation rate is lower than most estimates of its trend, while wage growth remains sluggish, suggesting that some cyclical weakness persists. She added that GDP growth will maintain a sustained pace of growth strong enough to result in a further gradual decline in the unemployment rate.  On inflation she maintained the view expressed in the latest FOMC minutes  that  inflation would pick up towards the 2% target once the transitory effects of lower energy prices dissipate.

 Guidance on “patience” leaves room for flexibility

Fed Chair Yellen spent some time in clarifying the forward guidance for interest rate normalisation. She mentioned that patience remains necessary as long as inflation continues to run below the Committee’s 2% objective, while room for sustainable improvement in the labour market remains.  She stressed that dropping the term “patience” should not be read as indicating that the FOMC  will necessarily increase the target range in a couple of meetings.

 Timing for rate hike still open, but we expect June

Fed Chair Yellen used her testimony to prepare the public and financial market for a rate hike later this year. She maintains her view that a rate hike is unlikely in the next couple of meetings. But she emphasized that if economic conditions continue to improve, the FOMC will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis. Although we expect a strong labour market to continue driving the economy, we think both headline and core inflation will remain subdued for a while. Our base scenario is for a rate hike in June. Downside risks to core inflation in coming months, suggest there is a chance of a slightly later move.

25 Feb

Greece announces ambitious reforms, …

Late Monday night, Greece’s finance minister Yanis Varoufakis specified a long list of planned reforms. They touch upon almost every element of Greece’s economy and social system. A main element of the plans is a tax overhaul, largely by fighting tax fraud and tax evasion and by eliminating tax code exemptions. Also on the agenda are reforms of the pension and health care systems, as well as reforms of the labour market and product markets, e.g. by lifting barriers to competition. Last but not least, the government wants to fight the humanitarian crisis, while ensuring that is has ‘no negative fiscal effects’. During the reform process, the Greek government wants to consult and work in collaboration with European and international institutions, including the EU, OECD and ILO. This should help the country gaining support for its plans from the institutions.

 … but tough negotiations still lie ahead

The Eurogroup and institutions have approved the list of planned reforms. This was a condition for the four-month extension of Greece’s financial facility with the EU-IMF. It has to be seen as a starting point of a complete review by the institutions, for which further details will be needed.  Therefore, tough negotiations still lie ahead. However, the current approval is a crucial step towards a more permanent solution.