Weak US data clouds Dec rate hike possibility

Even as the US Federal Reserve insists the December rate hike plan is firmly in play, its San Francisco President John Williams feels it is required to study more economic data surfacing in the coming weeks before taking a decision to raise its key short-term rates. In fact, in its policy statement, the Fed clarified that "it could decide on a rate hike at its next meeting to avoid surprising investors in case it did raise rates then."

Willams, who is a voting member of Fed's policy setting panel, felt the central bank needs to fully understand the 'low neutral interest rates', which are considered a warning sign of possible changes in the economy. US authorities are expected to release job data this week, which may hold key to rate hike, which will have consequences beyond the US borders.

According to a Reuters report, the economists say the average job gains above 1,50,000 a month in October and November may strengthen the Fed decision to hike the rates in December. However, the US job market is not alone Fed’s concern as it made an explicit reference to global economic seen during its September review.

Meanwhile, financial research groups predict that the Fed may raise interest rate to 0.25 per cent or even 0.50 per cent from its present 0.125 per cent on December 16. On the spending front, the US consumer spending in September has slight gained, suggesting a flat domestic demand. Interestingly, the third quarter spending was up 3.2 per cent, thus lifting the GDP growth to a 1.5 per cent rate, explains the quarter-end report.

As per the University of Michigan’s consumer sentiment index, consumer spending growth is unlikely to maintain a brisk pace, as was seen in the second and the third quarters, especially in the absence of income rise. The wages and salaries reported fall in September, more so in manufacturing, after an increase of 0.4 per cent in August. US inflation is persistently below the Fed’s 2 per cent target. With sluggish spending and weak inflation, it would be difficult for the Fed to take a decision to hike rates in December, as feared by its official John Williams.

What is a neutral interest rate?

To define, the neutral (or natural) rate of interest is the rate at which the real GDP is growing at its trend rate, and inflation is stable. The economic theory explains that the changes in neutral interest rates reflect changes in real economic factors like population growth, productivity growth, preferences for savings and global conditions. It means that the neutral rate is determined by private preferences and opportunities. It reflects the price of shifting resources from one period to the next. Hence, the neutral rate balances the choices of all participants in the market, on an average over time. For instance, if people prefer to save today and spend tomorrow, then the interest rate will be positive.

By KVVV Charya