The Fed's long-running review has been in progress since late 2018 and has been looking into how the central bank can best use its tools and communicative strategies to meet its employment and inflation objectives in a world of structurally lower interest rates. The onset of the pandemic has only accentuated the importance of the review given the Fed's shift to ultra-loose policy settings. It has been widely touted that the Fed will shift to an average inflation-targeting regime in which it will take into consideration earlier periods of low inflation and thus allow it to tolerate periods of overshoot of its 2% inflation objective. Such a shift would pave the way for the existing monetary policy stance to be left in place for longer, or perhaps eased further, providing a more extended period of accommodation to both financial conditions and the recovery of the US economy. The July minutes also showed detailed consideration of options to provide more explicit forward guidance to markets in terms of the economic outcomes that would need to be achieved before rates would start to be increased, or alternatively, it could turn to a calendar-based approach where it would pledge to not lift rates before a specified period of time had elapsed. Another option that has come under consideration has been yield curve control, similar to the approach used by the Reserve Bank of Australia, though the July minutes suggest this is out of favour with the FOMC.
On conditions within the US economy, the FOMC remains firmly of the view that the path of the virus is the key factor in determining the sustainability of the recovery. In the near term, the pandemic was assessed to be weighing heavily on economic activity and employment and was leading to disinflationary pressures overall with the hit to demand outweighing price rises stemming from supply-side disruptions. Given that there had been signs of a slowdown within higher-frequency indicators such as credit card spending and mobility data recently, the FOMC saw risks that the medium-term outlook for the domestic economy could weaken. However, that slowdown is yet to show up in the more conventional data which remains robust. According to Markit's flash Purchasing Managers' Index (PMI) readings for August, momentum in the US economy was picking up as activity on a composite basis advanced to 54.7 from 50.3 (readings > 50 indicate expansion) — its fastest pace of growth in 18 months. The services sector led the improvement with activity firming to 54.8 from a steady outcome in July, while the manufacturing sector also saw a faster pace of expansion to 53.6 from 50.9 as output and new orders picked up. Meanwhile, existing-home sales surged at a record pace in rising by 24.7%m/m in July with low rates and pent up demand driving a rebound in the housing market.
Over in Europe this week, the account of the mid-July meeting by the Governing Council of the European Central Bank highlighted caution around the economic outlook and was wary of the rebound being reported in the data through the initial phase of the reopening not being sustained. Evidence of this was seen in August's preliminary Markit PMI readings for the euro area, with activity on a composite basis falling from 54.4 to 51.6, suggesting that the pace of the recovery was moderating. A return of virus-related concerns saw activity in the services sector pullback from 54.7 to 50.1, though the manufacturing sector showed resilience with activity essentially unchanged on the month prior. The other key aspect within the July account was the argument from some members that the €1,350bn envelope of its Pandemic Emergency Purchase Programme "should be considered a ceiling rather than a target". However, the prevailing consensus of the Governing Council is that the envelope will be used in full to support the transmission of the ECB's monetary policy stance across the continent and to address risks to its inflation objective. On inflation, CPI in the euro area was little changed in rising by 0.1ppt to a 0.4% pace through the year to July, with higher energy prices post shutdown helping to lift it off the low point reached back in May (see chart, below). The UK also reported its latest inflation outcomes for July this week, with the headline CPI advancing above consensus in rising from 0.8% to 1.1%Y/Y driven by increased prices for petrol and clothing. The uptick in inflation in the euro area and in the UK follows a stronger-than-expected CPI print in the US last week (1.0%Y/Y) but is more likely to reflect volatility in the data as these economies reopen rather than the building of price pressures, though constraints on supply amid ongoing restrictions could be a factor.
Chart of the week
