Monetary Policy: No Surprise Here
As widely anticipated, the Federal Open Market Committee (FOMC) left the target level of the federal funds rate unchanged at 5.25 percent this afternoon. It was the seventh consecutive meeting with no change. The inflation-adjusted fed funds rate remains near 3 percent, or about 400 b.p. above its low of June 2004.
Changes in the FOMC’s post-meeting statement language were minimal, largely reflecting information revealed since the March meeting. For instance, in its rationale the FOMC acknowledged the weak first-quarter GDP report, changing the first sentence of the second paragraph to “Economic growth slowed in the first part of the year …” from the March language, “Recent indicators have been mixed ….” The statement maintained its outlook that “the economy seems likely to expand at a moderate pace over the coming quarters.” The reference to inflation was made more concise, replacing “Recent readings on core inflation have been somewhat elevated,” with the statement “Core inflation remains somewhat elevated.”
The FOMC’s assessment of risk was unchanged. It kept the statement “the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected.” This language, which first surfaced in the March statement, seems to have been slowly digested in markets over the intermeeting period. The initial market reaction after the March meeting focused more on the previous meeting’s changes in rationale, which were made to give the Committee greater flexibility when writing its post-meeting statements.
At that time, the characterization of recent economic indicators was weaker than markets had anticipated; hence, it seemed to signal to markets that policy easing might occur sooner than they had anticipated. Indeed, the probability of a rate cut in July increased noticeably after the statement’s release. This reaction was quickly reversed, however, and market participants seemed to gradually put greater focus on the inflation risk, especially after a strong employment report. Accordingly, the prospect of a rate hike before summer’s end diminished.
Market reaction to today’s statement was limited, consistent with the minimalist approach to today’s changes. Prospects for a rate cut remain very unlikely according to implied probabilities of alternative outcomes for the August meeting.