The Federal Reserve could surprise a lot of folks and raise interest rates as soon as next March, which would be much sooner than the second-half 2015 initial hike many economists are expecting.
Analysts at Capital Economics wrote Thursday that a pick up in US economic activity will prompt the Fed to tighten monetary policy sooner than the market is ready for.
According to traders polled by Reuters, there’s a roughly 74% chance that the Fed will first hike rates in July 2015.
Here’s Capital Economics:
The recent strength evident in much of the incoming survey and activity data suggests that we were right to believe GDP growth would accelerate once credit conditions eased and the fiscal drag faded. We expect the economy to expand at an annualised pace of 3% over the next 18 months, prompting the Fed to begin raising its policy rate from near-zero next March.
One key argument in support of low rates has been what Fed chair Janet Yellen had called labour market slack. On Wednesday, Yellen said that the labour market still hadn’t recovered and continues to make “gradual process.” But here’s Capital Economics’ view:
We think that the disappointing 142,000 rise in payroll employment in August is a temporary blip rather than the start of a sustained slowdown. Our forecast that GDP will grow at annualised rates of around 3% over the next couple of years is consistent with payrolls rising by close to 200,000 a month.
Yellen said that inflation has increased since the beginning of this year, and the FOMC sees a decreased likelihood that inflation will continue to run below 2%, the Fed’s stated inflation goal. Capital Economics says inflation will rise much faster than the Fed anticipates.
We believe that the biggest surprise of next year will be a faster acceleration in core inflation than either the Federal Reserve or the financial markets are expecting. inflation will also be boosted by the continuing structural rebound in medical care inflation from last year’s 40-year low. The downward influences from the Affordable Care Act and the so-called drugs patent cliff are fading fast and we expect medical care inflation to rise from 2.0% in August to 3.5% by the end of next year. We do not expect inflation to take off. Instead, we just believe that a rise in both the main measures of core inflation above 2.0% early next year, and subsequently towards 2.5%, will catch the Federal Reserve off guard.
The analysts cited other factors that will compel the Fed to raise rates sooner than expected, including a little-changed budget deficit, and growth in business investment and consumption.
Fed watchers obsessed over the phrase “considerable time” ahead of the FOMC statement on Wednesday. The statement kept the phrase, with Janet Yellen providing no clues on the exact timing of rate hikes. Stocks tumbled when she said in March that the phrase meant as soon as six months.
March 2015 is roughly six months from now.
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