24.02 Weekly Viewpoint : FOMC minutes more hawkish than expected

FOMC minutes more hawkish than expected: a rate hike in March has become more likely, but is still not, for now, our central scenario. Watch out for data and Yellen’s speech on March 3rd……

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In Europe, data confirm that the recovery at an above-potential pace continues, and has in fact accelerated at the beginning of 2017. In the week, inflation could hit 2% for the first time since 2013, but this will be a flash in the pan. For how much longer will the hawkish front of the ECB Council accept the status quo?

The minutes of the FOMC meeting held at the end of January have been read by the market as relatively dovish, although in our view they reveal markedly more hawkish tones than those of the relatively neutral January release. The economic outlook remains positive, albeit with several “roughly balanced” risks, some skewed to the upside (fiscal policy, stock markets), and some to the downside negative (dollar, protectionism, financial fragility abroad), against a background of uncertainty over the new Administration’s policies. The monetary policy outlook of participants was “generally” little changed compared to December. Despite significant uncertainty, most participants continue to believe that “gradual adjustments” will probably be appropriate. No arguments emerge in favour of a faster upward pace for rates, although the exact meaning of the term “gradual” remains unclear: in 2015-16 this meant one hike a year, and the FOMC has provided no additional indications on top of those which emerged from the December projections, which point to a median estimate of three rate hikes. In discussing future moves, “many” participants believe it is appropriate to increase rates “fairly soon”, should data on the labour market and inflation trends match or beat expectations. “A few” participants noted that removing policy accommodation in a timely manner, even potentially at an upcoming meeting, would allow the Committee greater flexibility, and “a couple” of participants expressed concern that the market could misunderstand the notion of “gradual”, taking it for a commitment to only one or two hikes in 2017. It should be said that Yellen recently said that a hike will be considered at “upcoming meetings”: the use of the plural is important in this case, as it keeps focus on several dates.

In conclusion, the meeting sent a more explicit signal than had hitherto been the case that March could effectively be a viable date for a rate hike, which makes the forthcoming round of data releases over the next ten days even more relevant. However, the minutes continue to outline high uncertainty and a significant dispersion of opinions, which in all likeliness will result in several dissenting votes at the March meeting, whatever decision is taken on rates. We believe a fed funds rate increase in March has now become more likely, although it is still not our base case scenario. On 3 March, Yellen will deliver a speech which could prove relevant for a reassessment of the near term picture, in the wake of next week’s data releases.

In the euro area, macro data released in the week leave little doubt on the fact that the recovery at above-potential rates is solid, and GDP growth could accelerate at the beginning of the year to 0.5% q/q. This week, the flash estimate for February may point to an increase in euro area inflation to 2.0%, for the first time since 2013. However, this should only prove to be a flash in the pan. After being boosted by energy prices, in the spring overall inflation will be supported by a favourable statistical effect on core prices, which will wane starting in the summer, causing overall inflation to return towards 1.6% by the end of the year. The real issue remains the underlying trend, and whether or not there will be genuine increases in the next few months. For the time being, low core inflation, and high political uncertainty, will offer arguments to the less interventionist members of the Council, set on keeping monetary policy, and communication especially, unchanged. However, beyond official positions, the split within the Council is becoming deeper. The debate on when and how to exit QE and the negative interest rate regime, even only in initial form, will have to wait a little longer. However, if data prove to be equally strong in the spring, and if Marine Le Pen does not win the ballot stage of the Presidential elections in France in May, a discussion on the timing and operational details of an exit from QE and from the negative interest rate regime could begin in June.

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