HomeAction InsightCentral Bank ViewsFOMC More Optimistic On Inflation Outlook, Indicated 'Further Increase' In Interest Rates

FOMC More Optimistic On Inflation Outlook, Indicated ‘Further Increase’ In Interest Rates

The FOMC voted unanimously to leave the Fed funds rate unchanged at 1.25-1.5% in January. There were some minor changes in the accompanying statement but the theme continues to suggest that that gradual removal of monetary stimulus remains on track. Policymakers eventually took out the impacts of hurricanes in its economic forecasts and continued to see ‘solid’ growth in’ employment, household spending and business fixed investment’. Meanwhile, they acknowledged that core inflation has stopped declining, thus allowing them to maintain the view that inflation would strengthen this year then stabilize at around the 2% objective. The Fed reaffirmed the pledge to monitor the development closely. The market viewed the meeting outcome as slightly hawkish, sending Treasury yields modestly higher. CME’s 30-day Fed funds futures suggest that the market has now priced in 80% chance of rate hike in March, up from 74% before the announcement. Other barometers have suggested that chance of a March rate hike has increased to 90%.

On the economic developments, the Fed indicated that ‘gains in employment, household spending, and business fixed investment have been solid’. This was compared with the reference in the previous month that household spending was ‘expanding at a moderate pace’ while business investment spending picked up in recent quarters’. The language on inflation appeared slightly more upbeat. As noted in the statement, ‘on a 12-month basis, both overall inflation and inflation for items other than food and energy have continued to run below 2%’. In December, the Fed indicated that the abovementioned index ‘declined’ in 2017. Moreover, the Fed noted that ‘market-based measures of inflation compensation have increased in recent months but remain low; survey-based measures of longer-term inflation expectations are little changed, on balance’. It did not acknowledge the increase in the prior month.

On the monetary policy outlook, what drove the market more hawkish was the use of the word ‘further’. In the second paragraph, the market noted that ‘with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will remain strong’. This was followed by concluding statement which suggested that ‘the Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate’.

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