Fed to keep ratcheting rates up

The FOMC today raised the Fed funds rate by another 25 basis points, bring it to 3%. So far the Federal Reserve have raised rates eight consecutive times, by 200 basis points, since June last year. See Reuters, Bloomberg, Financial Times, AP and other media reports.

William Polley, like many others, had expected "we will see a press release that looks a lot like the last one". Yes and no. As Angry Bear shows in his marked up version of the FOMC's statement, there have been some significant changes:

The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. Recent data suggest that the solid pace of spending growth has slowed somewhat, partly in response to the earlier increases in energy prices. Labor market conditions, however, apparently continue to improve gradually. Though longer-term inflation expectations remain well contained, [See correction below] Pressures on inflation have picked up in recent months and pricing power is more evident. The rise in energy prices, however, has not notably fed through to core consumer prices.

The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.

The sections of the statement that are boldfaced are additions from last month's statement, while the portions struck out were in the last statement but not in this one.

The reference to a measured pace of rate increases remains, as had been expected. More significant is that the two caveats about inflation have been struck out. The additional sentence notes the slowing in spending. But this does not appear enough for the Fed to consider a halt to its current tightening cycle anytime soon.

In short, the Fed is less concerned about soft economic fundamentals and more woried about inflation than are markets. They are intent on ratcheting official rates higher to dampen inflationary pressures and expectations.

Confirmation for this reading comes from Greg Ip's front page Wall Street Jornal story on 29 April, Fed Sees Inflation As Bigger Threat Than a Slowdown, (subscription required).

Despite signs that economic growth is slowing, the Federal Reserve sees signs of an upward creep in inflation as a bigger threat -- and is likely to keep raising interest rates in the months ahead to curb it.

On Tuesday, the Fed likely will raise the target for its key short-term interest rate to 3% from 2.75%. … Fed increases are likely to continue at subsequent meetings unless the economy slows much more than it already has.

Mark Thoma provides interesting commentary by his colleague Tim Duy, a former Treasury official.  Tim argues that the WSJ story "was almost certainly placed by Greenspan. You don't go front page with a piece like that unless you are sourced from the top." (Hat tip to Brad DeLong).

Back on 17 March I predicted the Fed would raise US rates by at least 100 basis points to 3.5% by year-end. I now expecting rates to have reached 4.0% by then. Next year rates should peak at around 4.5%, in line with in-house Fed estimates of neutral nominal interest rates.

UPDATE: As William Polley notes in his comment below, the Fed "corrects previous release to add sentence in second paragraph, which was dropped inadvertently". That is, they have added back the sentence on inflation expectations. Hence the end of paragraph one now reads:

Labor market conditions, however, apparently continue to improve gradually. Pressures on inflation have picked up in recent months and pricing power is more evident. Longer-term inflation expectations remain well contained. [Emphasis added by Fed]

As Bill notes below, "That tempers it somewhat. It's pretty balanced and conditional in my view". In his weblog entry he adds:

The press release wasn't bad to begin with, and adding back that sentence (which has been there before) makes it marginally better. ...And I think that this statement keeps the door open to a faster or slower pace of monetary adjustment as needed. If you've been watching the intermeeting data, nothing in this statement should surprise you.

UPDATE 2: Bill Polley has a second post, with more details and reactions. David Altig at Macroblog has also posted on the missing sentence.  His post includes plenty of links, plus this great quote from Robert Brusca, chief economist for FAO Economics:

"This omission is very Freudian," said Brusca, who argued that the Fed was right the first time by saying inflationary pressures are mounting, but is in so much denial that it didn't notice it had left out a key sentence. 

Comments

[William Polley]

The FOMC issued a correction which adds back the sentence about long term inflation expectations. That tempers it somewhat. It's pretty balanced and conditional in my view. More at my blog.