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Wednesday, December 10, 2003

Trapped Between Too Much and Too Little

Things ain't easy right now for the Fed. Presentation is definitely a problem. They aren't talking about raising rates, and everyone wants to know why. The reason is the deflation risk, which if it has subsided has only done so very marginally - we don't have enough information yet to start making projections about first quarter 2004 growth with any reasonable degree of confidence. nor does anyone have a clue what's going to happen to productivity which is, after all, at the heart of the output gap problem. So it's deflation watch, but not too loudly. Otherwise we'll have the markets drawing concusions we wouldn't want them to draw, now would we? Still the debate over what the Fed 'really' meant continues:

But in a shift from the Fed's October 28 statement, the central bank suggested that deflation is less of a threat than previously stated. "The probability of an unwelcome fall in inflation has diminished in recent months and now appears almost equal to that of a rise in inflation," the Fed statement said. In October, the Fed said the threat from weak prices "exceeds" that of inflation. Dick Rippe at Prudential Securities called this shift a "slight nuance that deviated from expectations." The shift in what analysts call the Fed's "bias" or tendency for its next move, was shifted away from leaning toward a rate cut, but not quite enough to signal a rate hike, Rippe said. "This seems as though they have half of a bias," Rippe said. "The Fed didn't really remove it but it certainly isn't as strongly biased towards ease over inflation as they appeared in the past." Ian Shepherdson, chief US economist with High Frequency Economics, said the shift in language may be laying the groundwork for a rate hike in the early 2004. "This is a significant change -- it is the first time since January that the inflation risk has been balanced. In each of the previous five meetings the Fed has expressed concern over disinflation risk," Shepherdson said. Others analysts contended the Fed signaled it would be on hold for a longer period, probably through most of 2004.

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