USA
- US central bank Fed hikes policy rate, as expected, and announces to start balance sheet normalisation this year.
In the federal open market committee (FOMC) that took place last week, the Fed decided to raise the target rate of the federal funds rate by 25 basis point to 1.0 to 1.25 %; the fourth increase in the key policy rate since the Fed embarked on a rate hiking cycle in December 2015.
The statement says that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year. Inflation has declined recently and is running somewhat below the 2 percent target. The FOMC continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace. Inflation is expected to remain somewhat below 2 percent in the near term but to stabilize around the FOMC 2 percent objective over the medium term. The FOMC judges that near-term risks to the economic outlook appear roughly balanced, but it is monitoring inflation developments closely.
In contrast to the previous statement, the FOMC stated that it expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated (Figure 1). The program will gradually reduce the Fed’s securities holdings by decreasing reinvestment of principal payments from those securities.
In a separate press release, the Fed outlined the policy normalization principles and plans. The FOMC intends to gradually reduce the Fed’s securities holdings by decreasing its reinvestment of the principal payments it receives from securities it holds. Such payments will be reinvested only to the extent that they exceed gradually rising caps. For treasury securities, the cap will be 6 bln USD per month and will increase in steps of 6 bln USD at three-month intervals over 12 months until it reaches 30 bln USD per month. For agency debt and mortgagebacked securities, the cap will be 4 bln USD per months and will increase in steps of 4 bln USD at three months intervals over 12 months until it reaches 20 bln USD per month.
Eurozone
- ECB signalling first steps of gradual policy normalisation.
- However, inflation is projected to remain too low versus the target at least during 2018.
- Year-end ‘tapering’ therefore unlikely.
At the meeting that took place on 8th June, the governing council (GC) of the ECB decided that the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.0 %, 0.25 % and -0.40 % respectively. The GC expects the key ECB interest rates to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases. The phrase constitutes the quintessence of the forward guidance of the ECB’s monetary policy and was changed in the statement. Previously, the sentence said that the policy rates are expected “to remain at their present or lower levels for an extended period of time”. Hence, the forward guidance has become less expansionary by skipping the threat to further expand monetary policy in case needed (for example, by increasing the asset purchase programme or by introducing further instruments). The shift can be seen as part of a very slow and gradual policy
normalisation.
Regarding non-standard monetary policy measures, the GC confirmed that the net asset purchases (‘QE’), at the current monthly pace of 60 bln EUR, are intended to run until the end of December 2017, or beyond, if necessary, and in any case until the ECB sees a sustained adjustment in the path of inflation consistent with its inflation aim. If the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the ECB stands ready to increase the programme in terms of size and/or duration.
According to the press conference statement, the Euro Area economy shows stronger momentum and is projected to expand at a somewhat faster pace than previously expected. The GC sees the risks to the growth outlook now broadly balanced. Previously, the statement had referred to diminishing downside risks at this point. The change in the language is consistent with the removal of the “or lower” part from the forward guidance.
At the same time, the economic expansion has yet to translate into stronger inflation dynamics. So far, underlying inflation pressures continue to remain subdued. A substantial degree of monetary accommodation is still needed for underlying inflation
pressures to build up and support headline inflation in the medium term.
In a new paper that was published last week by the ECB1, economists find that the APP (the programme launched in 2015 and not including the subsequent recalibrations of the programme) had a significant upward effect on both real GDP and inflation in the Euro Area during the first two years. It is estimated that the contribution of the APP shock to real GDP was 0.18 percentage points during the first quarter of 2015 becoming then very small by the fourth quarter of 2016 (0.02 percentage points). The contribution of the APP shock to inflation was very small in the first quarter of 2015 (0.06 percentage points), increasing to 0.18 percentage points by the end of 2015 and to 0.36 percentage points by the fourth quarter of 2016. This might appear somewhat small owing to the fact that it only estimates the impact of the initial 2015 QE programme. Other papers and estimation techniques found that the APP increased inflation by around 40 basis points and output by around 1.1 % during two years (Gertler and Karadi (2013)).2 Wieladek and Garcia Pascual (2016) found an APP effect of 1.3 % on real GDP and 0.9 % on core CPI.3
The ECB published updated quarterly staff macroeconomic projections, where the real GDP growth projections were slightly higher and the inflation projections were slightly lower than in the previous forecasts. Over the projection horizon (2017-19), real GDP is expected to grow by 1.9 %, 1.8 % and 1.7 % (previously: 1.8 %, 1.7 % and 1.6 %). Inflation is expected to average 1.5 % in 2017. It is then set to dip to 1.3 % in 2018, before edging up to 1.6 % in 2019. In March, the ECB staff forecast inflation of 1.7 %, 1.6 % and 1.7 % for 2017-19. The inflation forecast has dipped by 0.3 % percentage points for next year implying a prolonged period of accommodative monetary policy and a very gradual approach towards normalisation. From that perspective, ‘tapering’ (a step-wise slowdown of monthly asset purchases towards zero) would look premature by year-end. The core inflation rate is expected to rise to 1.4 % in 2018 and to 1.7 % in 2019; while previously, the expected values were 1.5 % and 1.8 % for 2018/19
(Figure 1).