The Bank of Montreal report a week ago indicated the same.
Greenspan Paves the Way for Tighter Policy
Alan Greenspan, speaking before the Joint Economic Committee of Congress this morning, reinforced widespread expectations that the Fed will hike rates at the June 29-30 policy meeting. Greenspan suggested that, while inflation has not picked up yet, an outbreak is inevitable unless the economy slows to a more sustainable pace in the year ahead. With no indication that the economy will slow on its own, the speech implied that the Fed would need to act.
Greenspan commented that the economy could not continue to run at its current pace (above 4%) without eventually sparking inflation. Growth must slow to a safer rate (presumably below 3%) or recent imbalances in the economy will worsen and eventually curtail the expansion. In particular, "should labour markets continue to tighten, significant increases in wages, in excess of productivity growth, will inevitably emerge, absent the unlikely repeal of the law of supply and demand."
Greenspan noted that "part" of the 75-basis-points rate cut in the fall "ceased to be necessary." This is because the fall easing was designed as insurance against the risk of recession. However, the US economy "has retained its momentum" and Asia and Latin America "are clearly on firmer footing." In fact, the previous easing actually raises the risk of inflation by stoking credit growth and domestic demand.
The rally in stock markets since the fall also heightens the risk of inflation. Greenspan noted that much of the economy's recent strength could be attributed to the wealth effect stemming from gains in share prices (and housing prices).
The Chairman warned that, to ensure a sustained expansion, "it is useful to preempt forces of imbalance before they threaten economic stability." He noted that "modest preemptive actions can obviate the need of more drastic actions at a later date." As well, "when we can be preemptive we should be," a likely reference to the fact that, because financial markets have already discounted a near-term tightening, actual tightening will likely not disrupt the recent stability in emerging markets.
While higher rates appear inevitable, nothing in Greenspan's speech pointed to an aggressive course of tightening. This is because "for the period immediately ahead, inflationary pressures still seem well contained." Greenspan appears ready to take back some of the fall ease in coming months and then pause to see whether the economy slows sufficiently to prevent the unemployment rate from falling further.
In our view, however, the Fed will need to raise rates by more than 50 or 75 basis points to slow the economy sufficiently to contain inflation. Our outlook for a one-percentage point rise in inflation, continued above-trend growth and a lower unemployment rate in the year ahead implies that the Fed will need to do more than unwind the fall ease. Thus, we expect policymakers to raise rates in increments of 25 basis points at the next two policy meetings and again in the fourth quarter. We foresee two additional moves in the first half of next year, taking the fed funds rate up to 6% from the current 4¾%.
By hinting at the need for modest, rather than aggressive, tightening, Greenspan's testimony spurred a mild relief rally in debt markets. Short-term interest rates eased about 3 basis points, while longer-term rates fell 6 basis points with the yield on 30-year Treasuries at 6.00%. The Dow rose slightly. The US dollar was little changed against the Canadian dollar and the major overseas currencies. |
