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Morning Briefing

Special Analysis:


The statement issued after the FOMC meeting on 01-02 Feb, 2005 is as follows:

The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 2-1/2 percent.

"The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity.Output appears to be growing at a moderate pace despite the rise in energy prices,and labor market conditions continue to improve gradually. Inflation and longer-term inflation expectations remain well contained.

The Committee perceives the upside and downside risks to the attainment of both sustainable growth and price stability for the next few quarters to be roughly equal. With underlying inflation expected to be relatively low, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability."

From the above, we can say that Dr Alan Greenspan, as Chairman of the Federal Reserve, is currently watching Productivity, Output, Energy Prices, Labour Market conditions and Inflation (both short term, as well as long term) in order to decide the course of Monetary Policy. We shall examine each of these variables to see how they have been changing over the past several years and what their future prospects are.

US Productivity
Productivity:-  The chart alongside shows the quarterly changes in US Productivity. Although the productivity growth in Q4-04 was lower than in Q3-4, productivity for the year 2004 as a whole has been registered at 4.1%, which is just a small dip from the levels of 4.4% in 2002 and 2003.
In other words of the Fed, it is "providing support to economic activity".
US GDP Growth
Output:-  As can be seen, US GDP has been growing since Q3-2001. It clocked 3.1% in Q4-2004 and the 4-period Moving Average may be bottoming out after having dipped a bit through 2004.
In the words of the Fed,"Output is growing at a moderate pace".
We may add that US GDP growth is unlikely to fall sharply.
Nymex Light Sweet Crude Futures
Energy Prices:-  Nymex Light Sweet Crude Futures have dipped after the US Election last year.Overall, however, Oil prices have been rising since April 2001. But, as observed by the Fed, "Output appears to be growing at a moderate pace despite the rise in energy prices". Or in other words,underlying output growth is strong and may not require monetary policy accommodation.
Labour Market Conditions
Labour Market Conditions:- This chart tracks the annual change in US wage rates. Wages have been growing at a faster rate in the last 12 months after having fallen in the preceding 3 years from Dec-00. This series lags the GDP growth rate by about 2-3 years. GDP bottomed in 2001, wages bottomed out in 2004 and are back at the growth rates seen in Feb-95. Further increases may be expected in line with the Fedís observation that" labor market conditions continue to improve gradually".
Inflation:-  The Inflation rate has picked up slightly over the past couple of years since Dec-02,when price increases were actually negative, the lowest since 1981. Such low prices were the result of the fall in US GDP growth since 2000, and so the recent rise is to be welcomed.In the bigger picture, however, prices are on a declining path since 1981.In the words of the Fed,"Inflation and longerterm inflation expectations remain well contained."
The picture that emerges from all the above is that the US economy has started growing again ince 2002 after having dipped sharply since 1999-2000. Therefore, as the economy continues to grow slowly, monetary accommodation, which had been earlier provided to counter the fall in GDP, can be slowly removed by increasing interest rates. As the Fed Funds Rate (2.5%) is just marginally higher than the PPI (2.19%),Real Interest Rates are not high at all, and there is room for further increases in the months ahead.

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