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The Federal Reserve’s latest policy statement was cognizant of the downside risks to growth. As usual, though, the FOMC is looking to keep inflation expectations in check, which is why they made a point of saying that upside inflation risks are of “significant concern.” Furthermore, Minneapolis Fed President Gary Stern noted on Tuesday that interest rates would likely need to be raised before the economy and credit markets fully recovered, and overnight index swaps are still pricing in over 75bps worth of hikes within the next 12 months. However, with Mr. Stern suggesting that the FOMC would prefer to take their time before shifting their policy stance as concerns regarding price pressures start to ease with the drop in oil prices from record highs, this Thursday’s US CPI release will go a long way to confirm or dispel the Fed’s worries.

US Fed: Rates Likely To Stay At 2% This Year, But Don’t Expect the Hawkish Commentary to Stop

The Federal Reserve’s latest policy statement was cognizant of the downside risks to growth. As usual, though, the FOMC is looking to keep inflation expectations in check, which is why they made a point of saying that upside inflation risks are of “significant concern.” Furthermore, Minneapolis Fed President Gary Stern noted on Tuesday that interest rates would likely need to be raised before the economy and credit markets fully recovered, and overnight index swaps are still pricing in over 75bps worth of hikes within the next 12 months. However, with Mr. Stern suggesting that the FOMC would prefer to take their time before shifting their policy stance as concerns regarding price pressures start to ease with the drop in oil prices from record highs, this Thursday's US CPI release will go a long way to confirm or dispel the Fed’s worries.

Federal Reserve Open Market Committee Policy Statement

			“Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth…Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee.”

Gary Stern, Federal Reserve Bank of Minneapolis President

			“From my perspective...I had been expecting oil to level off, because that's the way the futures markets were pricing it, so it seemed that if that happened, headline inflation would abate a bit, at least. Now, with the decline in energy prices, and assuming that sticks, that clearly improves the inflation outlook relative to what I was earlier expecting.”
			In his reiteration of the need to increase interest rates before the economy and credit markets fully recover, Mr. Stern said, “for a time the signals will be mixed…If you wait till you have conclusive evidence, you run the risk of waiting too long, and so, the real message is, you've got to be willing, at some point along the way, to say, 'You know, I have enough confidence in my outlook; it's time to go.”
			“My guess is, it's going to pay to be patient at this point, especially with the developments we've seen on the energy side, where, at least from my perception, some of the concerns about inflation and some inflation expectations seem to have diminished.”

ECB: Rate Hikes Off the Table, but Don’t Expect a Cut Anytime Soon

The European Central Bank left rates unchanged at 4.25 percent as expected last week, but the Euro pulled back sharply as ECB President Jean-Claude Trichet appears to be turning his focus toward the downside risks to growth. As a result, traders are starting to consider the potential for a 25bp rate cut by the central bank within the next year. However, traders should not be quick to forget that the ECB’s primary mandate is to maintain price stability, and while the bank is sure to reduce rates at some point, it is unlikely to occur until 2009.

Jean-Claude Trichet, European Central Bank President

			“The information that has become available since our previous meeting has further underpinned the reasoning behind our decision to increase interest rates in July. It has confirmed that annual inflation rates are likely to remain well above levels consistent with price stability for a protracted period of time and that risks to price stability over the medium term remain on the upside.”
			“Overall, downside risks (to growth) prevail. In particular, risks stem from the dampening impact on consumption and investment of further unanticipated increases in energy and food prices. Moreover, downside risks continue to relate to the potential for the financial market tensions to affect the real economy more adversely than currently anticipated.”
			“…a month ago I said that we would have, at mid-year, a trough…and that we should, in any case, add up the first quarter and the second quarter to take into account the fact that the first quarter was, in certain economies in particular and in the euro area as a whole, exceptionally robust. And I will certainly confirm that. We will see what our new forecasts, our new staff projections, are when we meet in September. Then I will display the new staff projections and I will be more in a position to comment on your question.”

Axel Weber, European Central Bank Governing Council Member

			“We don't expect the inflation rate in the euro area will fall back below our stability ceiling of just below 2 percent this year or next…We have a very gloomy inflation outlook. That makes it all the more important that we prevent second round effects.”

Lorenzo Bini Smaghi, European Central Bank Executive Board Member

			“The European economy is slowing down, more rapidly than forecast, due to a number of factors, first of all past months' increase in the prices of raw materials, which cut into purchasing power…Many indicators point to a worsening in growth expectations. There are many risks, which we flagged in the past, and which are partly materializing. We could see a phase of protracted weakness in coming quarters.”

Compiled by Terri Belkas, Currency Strategist for DailyFX.com

Questions? Comments? E-mail: tbelkas@dailyfx.com