Market commentary: Yellen continues to signal towards rate hike

Federal Reserve policy makers may need to have more than just confidence that inflation will pick up to raise interest rates again after liftoff according to chair Janet Yellen.

Yellen yesterday suggested that the pace of future rate increases could depend on “actual progress” in price gains toward the central bank’s target. That’s a shift from the requirement the Federal Open Market Committee set for an initial move, to be “reasonably confident” that inflation would move back to its goal over the medium term.

The language adds to reasons to expect that rates will rise gradually after a widely-anticipated liftoff later this month. As measured by the personal consumption expenditures price index, the Fed’s favorite gauge, headline inflation climbed just 0.2 percent in the year through October. So-called core prices, which strip out volatile food and energy costs, rose 1.3 percent.

“Given the persistent shortfall in inflation from our 2 percent objective, the Committee will, of course, carefully monitor actual progress toward our inflation goal as we make decisions over time on the appropriate path for the federal funds rate,” Yellen told the Economic Club of Washington on Wednesday.

On the other side of the pond, the spotlight is on the future moves of ECB president Mario Draghi. Halfway into a 1.1 trillion-euro asset- purchase plan, inflation is still hovering around zero, and policy makers have become increasingly concerned that it will become entrenched at low levels. ECB chief economist Peter Praet has warned that any further delay in bringing price growth back toward the goal of just under 2 percent risks harming the central bank’s credibility.

Draghi primed investors for more stimulus six weeks ago and reiterated his pledge in a Nov. 20 speech, when he declared that officials “will do what we must to raise inflation as quickly as possible,” using all available instruments within the mandate. All economists in a Bloomberg survey expect action today.

Any decision to ease policy may not be unanimous. Several officials including Germany’s Jens Weidmann and Estonia’s Ardo Hansson have voiced their misgivings about easing policy again, pointing to a slow yet gradual economic recovery and the stimulus effects from oil-price induced low inflation.

Draghi has repeatedly stated that the ECB can alter the composition, size or duration of its quantitative-easing program, its main stimulus tool. While bond-buying is scheduled to run until September 2016, policy makers have stressed from the beginning that it would continue until inflation was on a sustainable path toward the ECB’s goal. A commitment now to extend purchases for an extra 6 or 12 months would signal another considerable increase in the size of the ECB’s balance sheet.

Stepping up the pace of monthly purchases is also an option, even if some analysts say that the ECB could run short of bonds to buy by late-2016. A fix to that could come from expanding the universe of purchasable assets, for example by adding corporate or municipal debt to the mix.

In his four years at the helm of the ECB, Draghi has built a reputation for surprising investors with bold and unprecedented action. That has created expectations for today’s meeting, and poses the risk that positive financial conditions reverse if he is perceived to have delivered less than he was expected to.

This article was issued by Simon Psaila, Treasury Officer at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.