Fed rate action commentary from Swiss Re Chief US economist

21 March 2007, Zurich, New York

After today's decision by the Federal Reserve to hold the target fed funds rate at 5.25%, Swiss Re's US chief economist, Kurt Karl, commented, "The economic indicators continue to be mixed, but clearly inflation is not falling rapidly, so the Federal Reserve Board will need to hold interest rates constant at 5.25% for a few more months. Economic activity is below trend, which is helping ease inflationary pressures, but there has not been sufficient actual decline in inflation for the Fed to cut rates. By mid-year, core CPI inflation is expected to be close to 2.0%, allowing the Fed to ease in August."

"There are still two scenarios for the US: a soft landing (our baseline forecast) and a mild recession. The latest report on real GDP growth in the US, at 2.2% for 2006Q4 — revised down from 3.5%, showed continued signs of weakness. This was the third quarter in a row of below-trend growth. The economic indicators for January and February remain mixed. The most serious indication of a potential recession was from the advanced durable goods report which revealed a sharp drop in durable goods orders. If businesses cease to invest and hire, a recession is likely. Currently, the risk of recession this year is estimated to be 35%. Weaker orders, a more deeply inverted yield curve, and the plunge in the stock market in late February are contributing to this elevated risk of recession. The data over the next few months should provide a clearer estimate of the probability of a recession," Karl said.

"Growth remains solid outside of the US, which tends to reduce the risk of US recession, given the low value of the US dollar. Some tightening is expected overseas, however, which will slow growth modestly. Our current forecast assumes the European Central Bank and the Bank of England raise rates a final time to 4.0% and 5.5%, respectively. The Bank of Japan will raise its policy rate to 0.75% by end-2007, perhaps higher, while China will tighten monetary policy modestly with a renminbi appreciation of 3 to 4% and other financial measures. The Bank of Canada is likely to follow the example of the Fed and cut rates modestly. Long-term government bond interest rates in the Euro area, as in the US, are projected to increase modestly in response to ECB tightening, remain in a trading range near current levels in the UK, and rise in Japan as the BoJ raises rates," added Karl.

Notes to editors 

Swiss Re

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