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United States Monetary Policy May 2018

United States: Federal Reserve leaves rates unchanged in May; stays on course for a likely hike in June

At its 1–2 May monetary policy meeting, the Federal Reserve’s Open Market Committee (FOMC) unanimously decided to maintain its target range for the federal funds rate at between 1.50% and 1.75%. Following the rate hike in March, this move was widely expected by market participants, who were instead focused on subtle clues in the FOMC statement that could signal the path forward for interest rate decisions. In that light, the Fed sounded marginally more hawkish in its latest communiqué compared to March, mainly due to a stronger inflation outlook.

The rate decision came amid an environment of healthy economic growth supported by strong non-residential investment and a tightening labor market, which is fanning inflationary pressures. This was reflected in the communiqué that followed the monetary policy meeting, although some of the changes in language made indicated that committee members also accounted for some signs of softening. On the positive side, business fixed investment, which was seen as moderating in the March policy meeting, was now seen as continuing “to grow strongly” as of May. However, job gains in recent months were now seen as strong only “on average”, and the FOMC removed the phrase that “the economic outlook has strengthened in recent months”, signaling that growth momentum waned somewhat.

On the inflation front, the press release clearly indicated an improvement in the outlook, despite the fact that “market-based measures of inflation compensation remain low”. The Fed now expects inflation to “run near” its target of 2% in the coming 12 months. The communiqué removed the line that “the Committee is monitoring inflation developments closely”, which indicates that the FOMC is now less preoccupied with the possibility of inflation surprises in coming months, either to the downside or the upside. Indeed, the press release also mentioned that the Fed’s inflation target was symmetrical, a small but crucially important change in wording compared to the March statement, which allows the Fed to communicate to markets that it now expects inflation could very well exceed 2% for a sustained period. Such an occurrence would not be a cause for concern in the institution’s view, following past years of prolonged inflation undershoots.

The May policy meeting was not accompanied by an update to the Committee’s Summary of Economic Projections, in which the economic forecasts and interest rate projections—the Fed’s “dot plot”—of each Committee member are compiled. Therefore, the next policy meeting, on 12–13 June, will likely be crucial for market participants to determine whether the Fed is leaning towards two or three more rate hikes this year, especially considering that the latest dot plot showed Committee members split almost 50-50 on the decision as of March. A large majority of FocusEconomics panelists expect the Fed to raise the federal funds rate by 25 bp at its June meeting, to a range of between 1.75% and 2.00%. Furthermore, with some of the most dovish members of the Committee not voting this year, risks are mostly skewed to four interest rate increases being delivered in 2018, a scenario that our panel is increasingly forecasting.

United States Interest Rate Forecast

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