FOMC Widens Scope Of Possible Interest Rate Changes

Tuesday, August 30, 2005

A slight change in the wording on future monetary policy is the most outstanding paragraph from the FOMC minutes from the latest Fed meeting three weeks ago. Until now the Federal Reserve's key point was to tighten monetary policy at a measured pace; i.e. 25 basis points at a time. Now, after 10 equal steps to a Fed Funds Rate of 3.50 percent, the FOMC puts more emphasis on containing inflation in times of runaway oil prices. While staying on a measured pace is still tantamount, participants were of the opinion, that the pace and extent of policy adjustment would depend to a high degree on economic developments. Oil prices rose to a record of $70 bpd today, raising fears of a global economic slowdown.
From the FOMC minutes:
"In their discussion of current conditions and the economic outlook, meeting participants noted that aggregate spending appeared to have picked up in recent months by more than anticipated and that current estimates of slack were narrower than those reviewed at the June meeting. In addition, high and rising energy prices were adding to pressures on overall inflation, and energy price increases probably would feed through, at least temporarily, to core measures of inflation. Nonetheless, core inflation recently had been relatively low and inflation expectations remained well contained. Moreover, participants thought that some slowing in final sales was likely later this year as net exports resumed their decline and purchases of automobiles fell back with the expiration of special discount programs. In these circumstances, it appeared that, for now, continued removal of policy accommodation at a measured pace still would likely be sufficient to keep inflation contained, but participants also recognized that the pace and cumulative extent of policy adjustment going forward would depend importantly on economic developments."
The FOMC members also cautioned about the total effect of increased tax collections on the federal budget deficit this year.
"Regarding the federal budget, a recent narrowing of the deficit was noted, but the improvement appeared to be attributable to cyclical factors and to increases in the level of tax collections that were not likely to be repeated. Few signs were evident that greater fiscal discipline in the budget process would emerge any time soon. As a result, federal deficits were expected to continue to act as a considerable drain on national saving over the longer run."
The rest of the minutes resembled an uninspiring round-up of recent economic indicators, painting a slightly positive picture for the time being.
The wording on the housing market , which had changed from "hot" on May 3 to "robust" and "cooling in certain areas" this time.
The next FOMC meeting is scheduled for September 20.
Far more interesting appears the September 15 meeting of the Fed New York with the top-brass of derivatives trading of 14 major banks, Reuters had reported last week, citing a letter which bankers had received. Regulators from Britain, Germany and Switzerland will be attending the meeting too. Such a big event is unprecedented in economic times which the FOMC has been describing rather complacently.
The Federal Reserve has earlier this year repeatedly voiced concerns about the growth in credit derivatives, highly complex and difficult to price investment instruments. Both Fed chairman Alan Greenspan and governor Donald Kohn have asked banks to advance to more stringent risk measurement systems and increase their stress testing procedures.
Increased inflation pressure and the threat of slowing economic growth narrow the choices for the Fed, it seems. But maybe the American consumer will help. Insurance payouts in the wake of hurricane Katrina are very likely to get invested in household goods as soon as they will be distributed.

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