Fed to reiterate low interest rates warranted for an ‘extended period’

By Jeavon Lolay, Senior Global Macroeconomist, Corporate Markets

The Federal Reserve’s open market committee (FOMC) is expected to follow the recent decisions by the ECB, BoJ and BoE and keep interest rates pegged at a record low of 0-0.25% on Wednesday.

However, in the accompanying press statement, financial markets will also be looking for confirmation that the FOMC still believe that this is likely to remain the case for an ‘extended period’. After the comments from Fed chairman Bernanke last week, playing down market expectations of an early rise in US interest rates, they are unlikely to be disappointed. We forecast the first hike sometime in the second half of 2010.

The Fed’s main focus for now is likely to remain on how to continue with its various ‘non conventional’ schemes in place to support credit markets and economic activity. We believe there is a small risk of an extension to the previous timetable of asset purchases next year.

The BoJ is expected to keep its overnight interest rate at 0.1% on Friday, with the recent intensification of deflation suggesting this may remain the case throughout 2010. In other events, the Senate Banking Committee holds a confirmation vote for the nomination of Fed chairman Bernanke to a second term on Thursday. The BoE will publish its Quarterly Bulletin on Monday and its December Financial Stability and Trends in Lending reports on Friday.

It is a busy week for economic data this week, with financial markets searching for clues about both the pace of recovery and future inflationary trends. There are a host of consumer price indices released this week, including in the US, UK and euro zone. Figures for the UK are published tomorrow, with the annual CPI rate forecast to nudge up slightly to 1.6% in November from 1.5% in October.

The headline retail prices index (RPI) is expected to rise to 0.3% y/y, up from -0.8% in December and the first positive reading since January. November inflation data for the US and euro zone, due on Wednesday, should also show prices rising for the first time in several months.

We look for US annual CPI inflation to accelerate sharply to 1.8%, up from -0.2% in October, primarily reflecting the recent rise in energy prices compared to the sharp falls late last year. The revised euro zone data are expected to show no change from the initial estimate of 0.6% in November, up from -0.1% in October.

Although global annual inflation rates are likely to show further strong increases in coming months, we believe that any concerns about resurgent inflation are premature given the vast amount of spare capacity at present.

For us, the risks of inflation and deflation further out are still relatively closely balanced at this time.

UK

Following last week’s Pre-Budget Report (PBR), the UK’s public finances will again come under close scrutiny on Friday. We forecast the latest monthly data to show public sector net borrowing of £27.6bn in November, up sharply from £15.4bn last year.

The data should highlight that although financial markets were relatively unmoved by the levels of projected gilt issuance shown in the PBR in coming years, their support should not be taken for granted. Other prominent UK releases this week include labour market data on Wednesday and retail sales on Thursday.

We forecast a modest rise in claimant count unemployment in November, while the ILO unemployment rate is expected to be unchanged at 7.8% in the three months to October.

The more restrained rise in UK unemployment compared to previous recessions and to the sheer extent of the recent fall in gdp (see chart) has been a key feature of this downturn.

We believe this primarily reflects companies’ preferring to reduce pay and hours to contain labour costs on hopes that the downturn may prove short-lived. The clear risk is that final demand fails to meet their expectations, leading to further job losses next year. We look for the headline measure of average earnings growth to remain weak at slightly over 1% in the three months to October. Although the weak labour market will remain a key constraint on consumer spending for some time, we forecast UK retail sales rose modestly in November.

Eurozone

The other key data highlights this week include a series of important surveys in the euro zone, notably the German ZEW and IFO and the December PMIs.

We look for the surveys to signal that the overall pace of recovery will be maintained in the final quarter of 2009. The US November producer prices and manufacturing capacity utilisation data are expected to confirm that underlying price pressures remain subdued. Housing starts and permits, on Wednesday, could show a strong rebound after a surprise fall in October.

 

* All charts are sourced to Lloyds TSB Corporate Markets Economic Research, Bloomberg, IMF and Datastream

 


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