The Federal Reserve announced that it will be continuing along the path to slow interest rate normalisation on Wednesday. The Federal Reserve Open Market Committee decided to raise the target federal funds rate by 25 basis points.
“That's not surprising, given the economic progress that's occurred over the last year. We've had significant job gains, the unemployment rate is low, consumer spending is up, as is business investment.,” said Morningstar financial equities analyst Jim Sinegal.
“The one sticking point is still inflation, which remains below the Federal Reserve's 2% target. The Fed believes that this momentum in the economy will eventually raise inflation up over 2%. We've seen some small hints in the data, nothing yet to be concerned about, but the Fed is trying to get ahead of the puck here, so to speak.”
What Next for US Interest Rates?
David Page’s, Senior Economist at AXA IM today’s meeting garnered interest less for the immediate policy decision and more for its outlook of what the Fed might do over the coming years.
“The Fed now considers a profile of three increases in both this year and next and two hikes in 2020. This is implicitly consistent with our own outlook that considers four hikes this year, three next and one more in 2020,” he said.
Tim Foster, fixed income fund manager at Fidelity highlighted the new economic projections of a lower unemployment rate and a faster rate of growth, but with little to no impact on inflation.
“The message in a nutshell is that data, so far, is still not strong enough to justify a faster hiking cycle this year,” he concluded. “Further down the line, however, things are looking brighter, with either lingering slack or a long-awaited pick-up in productivity that will keep inflation under control.”
What Does it Mean for Today’s UK Rate Decision?
The Fed announcement comes less than 24 hours before the Bank of England is due to reveal its own interest rate decision. Wednesday also saw the latest job market figures in the UK, which were positive, potentially putting pressure on the Monetary Policy Committee to raise rates if not today, but in the near future.
Employment growth in the three months to January rose by 168,000, a seven-month high. The unemployment rate now sits at a 42 year low of 4.3%. Average earnings also rise, and the annual growth rate ticked up to a 15-month high – a tailwind for inflation.
It has been a busy week for economic data; Tuesday saw the latest inflation figures for the UK, which eased to a seven-month low in February to 2.7% from 3% the previous month. The fall was helped by a fall in petrol prices and smaller rises in food and transport costs, the Office for National Statistics said.
Page said the implications for the Bank of England were mixed.
“Faster employment growth, a fall in the unemployment rate and a rise in annual pay growth all suggest a tightening labour market that threatens domestically generated inflation and requires tighter monetary policy,” he said. “But given other downside risks to the UK outlook, primarily the ongoing impact of Brexit uncertainty on business investment, we argue that this would urge caution on the part of the MPC, which is why we forecast an August rate hike, after we see January-April wage hike evidence.”
However, Bank of England communication has led the market to conclude that it will tighten policy in May (suggested with a roughly two-thirds probability). Unlike the Grand Old Duke of York, the MPC is unlikely to want to run market expectations up for a hike, only to disappoint and see them come back down again. Governor Carney has been keen to stress that he does not provide specific rate outlooks except in exceptional circumstances. We suspect that tomorrow’s Bank Rate decision (where we expect no change in policy) will be the last opportunity to send a more equivocal signal to the market over the outlook for a May hike. We believe a more cautious outlook is warranted and for now maintain an August forecast, but tomorrow looks set to prove whether the MPC share our view.
