Fed rate action commentary from Swiss Re Chief US economist
12 December 2006, 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, "As expected, the Federal Reserve Board held interest rates constant at 5.25% today. Economic activity has slowed this year, reducing inflationary pressures, just as the Fed had hoped. Currently, the Fed needs to see substantial progress in the actual reduction of inflation before it becomes willing to cut rates. This is expected by mid-2007, when core consumer price inflation is projected to fall below 2.5% year-over-year. To achieve a ‘soft-landing,' which looks feasible, the economy must continue to grow at a moderate pace. However, the slowdown - coupled with volatile oil prices - has increased the risk of recession, so the Fed is walking a very tight line."
"Lower oil prices, a weaker US dollar and the resilient US consumer are likely to sustain positive growth next year. Housing construction appears to be stabilizing at 1.6 million starts and the auto sector decline in production is also mostly over — light vehicle sales should remain close to 16 million. As long as business investment holds up, a soft landing is assured. The current quarter, however, could be negative – if that spooks businesses and they stop hiring and investing, a recession will transpire. Inflation is abating, so the Fed is likely to cut rates next year, but only modestly. By year-end the Fed funds is now projected to be 4.75%, but it could well remain at 5.25% or 5.0% keeping the yield curve flat-to-inverted. As growth accelerates next year, the yield on the 10-year Treasury note should rise to 5% by end-2007. Real GDP growth is projected to be 2.6% next year, before accelerating to 3.1% in 2008." Karl said.
Outside the US, growth appears to be solid throughout the rest of the world, though it is expected to be less robust in 2007 than 2006. Our current forecast assumes the European Central Bank and the Bank of England hold rates constant in 2007, while the Bank of Japan raises its policy rate to 1.0% by end-2007. China will tighten monetary policy modestly by allowing a small appreciation of the renminbi. The Bank of Canada is likely to follow the example of the Fed and cut rates modestly. Long-term interest rates in Europe are projected to rise slightly in response to the increase in US long-term rates, while in Japan they will rise as the BoJ raises rates," added Karl.
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