The FOMC minutes confirmed the continuation of the gradual monetary tightening, euro zone PMIs edged lower

Macro Highlights - 3/1/2018

In short
  • In the US, the minutes of the Federal Reserve meeting indicated that the FOMC members anticipate an acceleration in GDP growth and a gradual rise in inflation...
  • ...which supports our scenario according to which the Fed will make three 25bp hikes in its fed funds rate in 2018, bringing it to 2.25%
  • In the euro zone, the purchasing managers index, despite remaining at a high level, indicated a dip in confidence in February, suggesting a slowdown in GDP growth at the start of 2018

United states – FOMC members expect an acceleration in growth in the short term, but do not seem to fear an overly sharp rise in inflation

With concerns regarding the inflation risk in the US resurfacing over the past few weeks, notably following the January employment report, which had signalled an acceleration in growth in the hourly wage to 2.9% y-o-y (see our Weekly of 12 February 2018), the publication of the minutes of the 31 January meeting of the Federal Reserve was highly awaited. The minutes of the meeting of the Federal Open Market Committee (FOMC) confirmed that, although its members believe that growth could accelerate in the coming months and help bring inflation closer to its target of 2.0%, they do not seem to be worried about it accelerating too sharply.

The minutes revealed that the FOMC members consider that the latest economic data points in the direction of GDP growth continuing at a pace above its potential. Moreover, some members indicated having revised their short -term growth forecasts slightly upward, notably due to the fact that the US Administration's stimulus measures appeared to be boosting activity more than initially expected.

According to the FOMC members, this growth momentum, the robust labour market and the drop of the dollar are set to contribute to bringing inflation close to its target of 2.0%. They nevertheless do not appear to be worried about an overly sharp rise in inflation, and continue to expect inflation growth to be “gradual”. Thus, the FOMC members consider that, although th e economic outlook increases the probability of further hikes in the fed funds rate, the most suitable approach would be for this to be done at a gradual pace.

Analysis and implications :

  • The FOMC minutes confirmed that the Fed is confident in the economic outlook and a gradual rise of inflation, and as a result should continue to raise its fed funds rate at a gradual pace
  • Although the implementation of the stimulus plan has led several FOMC members to revise their growth forecasts upwards, they did not indicate that they expect stronger inflation. This tends to confirm that they remain cautious in their estimate of the effects of the stimulus plan, which could reduce the inflationary risk if these effects include a rise in production capacity, as Mathilde Lemoine analysed1.[1]. 
  • Overall, the minutes of the FOMC meeting backs our scenario of three 25bp hikes in the fed funds rate in 2018, bringing it to 2.25% by the end of the year.

Euro zone - purchasing manager surveys indicate slightly lower confidence

GDP growth in the euro zone, which saw a strong acceleration in 2017 – from 1.9% y-o-y in Q4 2016 to 2.8% in Q3 2017 before stabilising at 2.7% in Q4, for annual growth of 2.5% following 1.8% in 2016 – could slow at the start of 2018. This is what the February PMI surveys suggest.

Euro zone PMIs were down in February, and dropped more sharply than expected by the consensus. The manufacturing PMI thus fell from 59.6 to 58.5 (vs. 59.2 expected), while the services index was down from 58.0 to 56.7 (vs. 57.6 expected) and the composite index, which combines the business trends in both of these sectors, dropped from 58.8 to 57.5 (whereas consensus was expecting 58.4).

In detail, most of the components of these surveys lost ground, but input prices and new orders fell most sharply, which could indicate that the effects of the rise of the euro since April 2017 are materialising. The input price component of the composite index was down from 61.8 to 60.0 in February, while the new orders component fell from 57.9 to 56.5. In the manufacturing sector, new orders were down by 1.5 points to 58.1 and new export orders down 1.6 points to 56.8. In services, the incoming new business component shed 1.3 points to 55.9.

Moreover, PMIs were down across euro zone countries. In Germany, both the manufacturing and services indices lost ground (down from 61.1 to 60.3 and from 57.3 to 55.3, respectively) while the composite index came in at 57.4 vs. 59.0. In France, the composite index dropped more sharply (from 59.6 to 57.8), while the manufacturing index fell from 58.4 to 56.1 and the servic es index from 59.2 to 57.9.

Analysis and implications :

  • After hitting a 12-year high in January, the euro zone composite PMI was down in February, which tends to indicate that GDP growth could decelerate slightly, as we expect.
  • According to our analysis, GDP growth in the euro zone, which benefited from a catch-up effect in 2017 in a context of stronger world growth, could slow, as GDP would return to its natural level, i.e. the level it would have reached if there had not been a crisis.
  • Moreover, while in 2017 the euro zone’s external trade benefited from the effects of the decline in the euro between mid-2014 and March 2017, it could now suffer from the close to 9.0% appreciation in the euro’s nominal effective exchange rate since April 2017 and, in particular, the 16% increase against the dollar.
  • According to our scenario, this slowdown in growth and the very limited rise in inflation, due notably to the appreciation of the euro, should lead the European Central Bank to maintain an accommodative monetary policy. As a result, we maintain our scenario according to which the ECB would end its asset purchase programme in September 2018, but would keep its key rates unchanged and continue to reinvest the amounts it receives when the securities it holds mature in 2018 and 2019.

[1] Voir l’analyse mensuelle de Mathilde Lemoine : « Et si la capacité de production des Etats-Unis augmentait grâce à la réforme fiscale ? », 23 février 2018