The outlook for the US economy has softened and there may be a more persistent slowdown on the cards overseas, bolstering the need for a period of “watchful waiting” on interest rates, a senior Federal Reserve policymaker said.
Lael Brainard told an audience in Princeton, New Jersey, that she had revised down her expectations for the economy this year in response to some weakening in consumer spending and other economic data. Even if a sharp drop in December retail sales is revised in future data releases, the decline points to slower growth in US consumer spending during the first quarter of 2019.
Ms Brainard also highlighted weaker construction data and “indications of softening” in business investment figures.
“This softening could be a harbinger of some slowing in the underlying momentum of domestic demand,” Ms Brainard said, according to the prepared text of her remarks. “Overall, the softer spending data in the US and the slowdown abroad, along with earlier financial volatility, are likely weighing on the modal outlook and might in turn warrant a softening in the modal path for policy.”
Her view confirms the mood of caution that is being expressed by central bankers around the world as global expansion hits a rockier patch.
The Fed in January shelved prior plans for additional rate rises, while earlier on Thursday the European Central Bank said it will keep rates on hold until 2020 and offered a fresh bout of cheap funding to banks in response to faltering euro area growth.
Ms Brainard said policy uncertainty has contributed to recent market volatility and remains a factor looking forward. A renewed escalation of trade disputes remains a risk, for example, she said, while in the US, a failure to reach a budget deal later this year could result in a sharp retrenchment in some parts of public spending.
More immediately a “no-deal” Brexit would have “adverse consequences” for the UK and potentially elsewhere given the City of London’s role as a financial centre, Ms Brainard warned.
Arguments for caution on rates in the US are heightened by tepid inflation, Ms Brainard said, pointing out that there has been only a “very weak” link between price growth and resource utilisation in the US economy for some time. “This raises the possibility that the economy may have more room to run,” said she added.
Given low inflation and the possibility that official rates will have to be cut to near-zero in future downturns there is a risk that private sector inflation expectations get pulled down in a “self-reinforcing spiral”. As such, a number of Fed policymakers have already been making policy projections that are consistent with temporary overshoots to the Fed’s 2 per cent inflation objective, observed Ms Brainard.
With a discussion looming at the Fed over its future approach to the inflation target, Ms Brainard hinted that she is interested in one strategy that has been advocated by former Fed chairman Ben Bernanke among others. This approach sees the central bank temporarily targeting the price level in downturns, as part of a pre-commitment to make up for pass undershoots to the inflation target.
Addressing the shorter-term outlook, Ms Brainard said:
“The most likely path for the economy appears to have softened against a backdrop of greater downside risks. Our goal now is to safeguard the progress we have made on full employment and target inflation. Prudence counsels a period of watchful waiting. And with balance sheet normalization now well advanced, it will soon be time to wind down our asset redemptions.”
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