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Tuesday, January 03, 2006

The Light at the End of the Tunnel is Getting Brighter

But how long is the tunnel? Anyone looking for a sign of a pause in rate hikes at the next FOMC meeting in today's release of the minutes from the last meeting will have a hard time finding it. However, after that there is less certainty. Committee members aren't entirely sure how much more tightening will be required, but "the number of additional firming steps required probably would not be large." Incoming data will be important in making this determination. Here's some highlights from the minutes followed by a longer version and a link to the entire text:

  • Core consumer price inflation was moderate in recent months, although some signs of pass-through of higher energy costs were evident, especially in transportation services.
  • Both overall and core consumer price inflation were projected to move higher in the first half of next year, reflecting the effects of higher energy prices, but then to trend lower as those effects ebb.
  • The economic expansion had shown considerable resilience ... suggesting greater underlying strength than had been apparent at the time of the November meeting.
  • [W]ith growth solid and prices of energy products still well above levels earlier in the year, possible increases in resource utilization had the potential to add to pressures on prices, especially in the absence of some further firming of policy.
  • Meeting participants discussed tentative signs that activity was beginning to slow in the housing sector. ... To date, however, the national data on home prices, sales, and construction activity did not suggest a significant weakening in the sector.
  • [I]n the view of a number of participants, the economy was possibly producing in the neighborhood of its potential, and the persistent strength in spending of late suggested that resource markets could tighten further and inflation pressures build. Under these circumstances, and with policy having been accommodative for some time, inflation expectations could rise if monetary policy were not seen as responding to contain such risks.
  • Views differed on how much further tightening might be required.
  • [T]he outlook for policy was seen by most members as indicating that, given the information now in hand, the number of additional firming steps required probably would not be large.
  • Some members thought that the word "measured" was no longer necessary, but its retention for this meeting was seen as potentially useful to preclude a possible misinterpretation that the Committee now saw a significant possibility of adjusting policy in larger increments in the near future.

The last point surprised me, but it gives some insight into how the Fed views the inflation risks. I would have thought the worry would be in the other direction, that removing the "measured" term might be interpreted as indicating the chance of a pause had risen. Here's a longer version of the minutes:

Minutes of the Federal Open Market Committee December 13, 2005: ... The information reviewed at this meeting suggested that the economy continued to expand at a solid rate in the fourth quarter. ... Although some scattered signs of cooling of the housing sector had emerged, the pace of construction activity and sales remained brisk. ... Core consumer price inflation remained subdued, even though some of the increase in energy costs had apparently passed through to prices of final goods and services. ... The unemployment rate held steady at 5 percent, and the labor force participation rate was also unchanged. ... Activity in the housing market remained brisk despite a rise in mortgage interest rates. ... Real outlays for equipment and software posted a solid gain in the third quarter. ...

Core consumer price inflation was moderate in recent months, although some signs of pass-through of higher energy costs were evident, especially in transportation services. ... Presumably in response to falling retail energy prices, one survey of households in November and early December showed a marked retreat in expectations for inflation over the coming year. Longer-term inflation expectations also edged down, but stayed a touch above the narrow range observed in recent years. ... overall producer price inflation remained subdued. With regard to labor costs, the ... employment cost index for private industry workers in September was well below its year-ago increase. Hourly compensation in the nonfarm business sector also appeared to have slowed a bit recently. ...

The staff forecast prepared for this meeting suggested that growth of economic activity would slow from this year's pace, but remain solid, with output staying near the economy's potential over the next two years. ... Both overall and core consumer price inflation were projected to move higher in the first half of next year, reflecting the effects of higher energy prices, but then to trend lower as those effects ebb.

In their discussion of the economic situation and outlook, meeting participants noted that incoming data over the intermeeting period had been encouraging with regard to both economic growth and inflation. The economic expansion had shown considerable resilience ... suggesting greater underlying strength than had been apparent at the time of the November meeting. At the same time, incoming inflation data had been benign, indicating relatively modest pass-through of higher energy prices to core inflation to date... and inflation expectations, which had jumped after the hurricanes, had fallen back. Nonetheless, with growth solid and prices of energy products still well above levels earlier in the year, possible increases in resource utilization had the potential to add to pressures on prices, especially in the absence of some further firming of policy. ...

Meeting participants discussed tentative signs that activity was beginning to slow in the housing sector. ... To date, however, the national data on home prices, sales, and construction activity did not suggest a significant weakening in the sector.

Business investment spending had accelerated some since midyear. ... Participants noted that the improved performance of investment suggested that the expansion was becoming more balanced, with strengthening business spending potentially offsetting some moderation in the growth of household spending ... Economic activity also could be buoyed by developments in other sectors of the economy. ...

In their discussion of prices, participants indicated that their concerns about near-term inflation pressures had eased somewhat over the intermeeting period. ... Nonetheless, surveys and anecdotal reports suggested that some firms were successfully passing at least a portion of their increased costs on to customers, and many participants remained concerned that elevated energy prices could put pressure on core inflation. Also, in the view of a number of participants, the economy was possibly producing in the neighborhood of its potential, and the persistent strength in spending of late suggested that resource markets could tighten further and inflation pressures build. Under these circumstances, and with policy having been accommodative for some time, inflation expectations could rise if monetary policy were not seen as responding to contain such risks.

In the Committee's discussion of monetary policy for the intermeeting period, all members favored raising the target federal funds rate 25 basis points to 4-1/4 percent. ... Committee members generally anticipated that policy would likely need to be firmed further going forward. In that process, the Committee would need to be mindful of the lags in the effect of policy firming on the economy. ... Views differed on how much further tightening might be required. ... members thought that the policy outlook was becoming considerably less certain and that policy decisions going forward would depend to an increased extent on the implications of incoming economic data for future growth and inflation.

The Committee agreed that several changes in the wording of the announcement ... would be appropriate. ... the Committee thought that policy should no longer be characterized as accommodative. Members concurred that the statement should note that the expansion remained solid ... [T]he outlook for policy was seen by most members as indicating that, given the information now in hand, the number of additional firming steps required probably would not be large. Some members thought that the word "measured" was no longer necessary, but its retention for this meeting was seen as potentially useful to preclude a possible misinterpretation that the Committee now saw a significant possibility of adjusting policy in larger increments in the near future. ... The members agreed that the announcement should end by noting that policy will respond to changes in economic prospects as needed to foster the Committee's objectives...

Other reports: Bloomberg, Washington Post, CNN/Money, Financial Times, Wall Street Journal, NY Times.

Blogs: The Big Picture, William Polley.  I will add more as I find them.

    Posted by on Tuesday, January 3, 2006 at 12:07 PM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (6)

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