Two months ago, in the June Summary of Economic Projections, we received indications that Committee participants had become more divided about when to begin the process of policy normalisation. The constellation of year-end policy rate projections implied that even the Committee leadership was divided on a September or December start. If anything, the 28-29 July meeting minutes released on 19 August threw the division among Committee participants into even starker relief.
Most participants believe that the economic conditions for policy firming are approaching. Still, the minutes reflected greater concern with downside risks to the growth and inflation outlook and more importantly, some doubt in Chair Yellen’s slack-based framework to the inflation outlook. In this framework, the Committee’s confidence in the inflation outlook should firm as the economy reaches full employment. But the latest minutes reveal that at least some members may doubt this construct. For example, “Several…cited evidence that the response of inflation to the elimination of resource slack might be attenuated”, and “considerable uncertainty remained about when wages might begin to accelerate and whether that development might translate into increased price inflation”.
To be fair, the slack-based framework might still be valid, but the economy might be further away from full employment than thought. This view was also represented in the meeting minutes, with several noting that the lack of acceleration in wages “might be signalling that the natural rate of unemployment could currently be lower than they previously thought”. Under either interpretation, a number of Committee participants appear to be quite far from having reasonable confidence that inflation will move back to objective over the medium term.
The minutes also revealed some greater concern about downside risks to the outlook, even as the post-meeting statement continued to view these risks as “nearly balanced”. Several participants noted that “a material slowdown in Chinese economic activity could pose risks,” and some highlighted “the risks to inflation from the possibility of further dollar appreciation and declines in commodity prices”. Some Committee members may now view these risks as higher than they were at the time of the meeting, given that commodity prices have continued to slide and China’s recent change in foreign exchange policy may create a near-term inflation headwind.
I am continuing to cling to a September rate increase call, because at the end of the day the minutes make clear that in July most Committee members saw the economic conditions for liftoff as approaching. Still, my view is very much dependent on continued strength in the labour market and a stabilisation in market-based measures of inflation compensation and financial conditions (which have deteriorated somewhat over the summer).
If anything, given uncertainty in the minutes about the inflation outlook, the hurdle to a September liftoff now appears a bit higher than previously thought, and a start to policy normalisation likely requires solid evidence of continuing economic momentum.