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The United States Federal Reserve is expected to leave its policy interest rates unchanged at its July 25-26 policy meeting. As the Fed raised interest rates by 0.25 percent for the third time in about seven months at its last meeting in June, it would be in keeping with its message that it plans to increase interest rates only gradually, if it holds off from a further rise at the upcoming meeting.
With financial markets attaching virtually a zero probability to a July monetary policy change, any move would be a huge surprise. But we see no reason why the Fed would want to deviate from market expectations. Markets now put less than a 50 percent probability on an interest rate hike this year. In contrast, last month’s latest forecast updates from FOMC participants still pointed to the likelihood of one further interest rate rise this year, followed by another three in 2018.
The primary driver of this divergence has been the recent decline in US inflation. Headline CPI inflation has fallen for four months in succession. This has been driven in part by the slippage in the oil price, but also reflects an easing in ‘core’ inflation. Inflation as measured by the Fed’s preferred measure, ‘core’ consumer expenditure deflator, has fallen from 1.8 percent at the start of the year to a current rate of 1.4 percent.
The inflation undershoot has convinced markets that the Fed is making a mistake in raising interest rates at its recent pace. In contrast, the majority on the Fed’s policy making committee are more inclined to regard the inflation dip as temporary and driven in part by “unusual reductions” in certain prices.
"We share the Fed’s expectation that inflation will eventually turn around. As a result, we expect one more rate rise this year and three more next year. However, we now feel it is more likely that it will delay the next rise until December while it monitors developments," Lloyds Bank commented in its latest research report.
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