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Eco Focus is an aperiodic publication providing up-to-the-minute analysis of a current topic.
Q2 real GDP growth rose at a 2.3% annual rate, following an upwardly revised 0.6% increase in Q1, while the PCE deflators showed a pickup in Q2 inflation rates. Stronger consumer spending and an improved net export position fuelled the Q2 GDP advance. Residential investment moved higher but fixed non-residential capex spending on equipment pulled back last quarter. We see GDP growth averaging around 2.8% in the second half.
As expected, there was no change in the fed funds target range (0 to 0.25%). The Fed's read on recent economic data was slightly more upbeat than in June, citing solid job gains, declining unemployment and diminished labor market slack. This suggests to us that the economy continues to move closer to meeting the FOMC's conditions to begin rate normalization.
No rate hikes are expected in July. Our base case remains a September lift-off. Fed officials are looking for more evidence that economic growth is sufficiently strong and labor market conditions continue to firm enough to return inflation to the Committee's longer-run 2% objective over the medium term before beginning the process of rate normalization.
US annual productivity growth has slowed since the 1970s, with a pronounced slowdown occurring during the recovery from the Great Recession. Weak productivity growth appears to reflect a combination of cyclical and structural factors as well as measurement issues.
Yesterday's decision by the ECB to increase ELA, even incrementally, is a positive surprise in terms of timing and a supportive signal to Greece. On the crucial assumption that Greece remains a member of the Eurozone, the ECB should continue to do just as much as it takes to keep Greek banks afloat through a further carefully calibrated ELA lift (as well as potentially loosening collateral haircuts) starting next week.
Were it not for Greece, the ECB would be enjoying a gradual, domestically-driven, QE-boosted Eurozone recovery while keeping a cautiously optimistic tone at its regular policy meeting on Thursday. Instead, the focus will remain firmly on the ECB's next move on ELA. A gradual, step-by-step increase in ELA looks likely, starting this week, conditional on the implementation of prior actions by the Greek government. Either way, capital controls are expected to be maintained.
Alexis Tsipras's surprise decision to call a referendum on proposals by Greece's creditors marked the end of negotiations. An agreement in principle on a number of issues had been found, but one key component was missing: the conditions governing a further debt restructuring. Tsipras is doing a balancing act between pressures from Syriza's left wing and the creditors, and in doing so is gambling his political survival.
The positive surprises provided by Swedish inflation data in May and the rebound in inflation expectations have lowered the odds of a rate cut from the Riksbank at its next meeting (1 July, announcement of decision on 2 July). We expect the Riksbank to leave the repo rate unchanged at -0.25%. We have delayed our expectation of a 10bp cut in the repo rate to September.
There was no change in the fed funds target range (0 to 0.25%) or the FOMC's portfolio reinvestment policy at today's meeting. The FOMC continues to anticipate that "it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term."
Draghi's "get used to volatility" comment should not be misinterpreted as an inflexible ECB stance. The ECB has kept a dovish bias, which suggests that it would respond to unwarranted monetary tightening eventually in case bond yields (especially real yields in the periphery) and potentially the EUR continue to grind higher.
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