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Eco Focus is an aperiodic publication providing up-to-the-minute analysis of a current topic.
The FY 2016 budget will not be passed before the beginning of the fiscal year. The responsible solution would be to pass a short-term continuing resolution (CR) to maintain funding for current government programs at the same pace as this year until an agreement can be reached. Some hard-core conservative Republicans favor a shutdown to make a political point. We believe the odds favor a last-minute short-term spending bill to avert a shutdown.
With its announcement of an extended programme of purchasing unsterilised assets (quantitative easing, QE), ECB seems to have come up with a response on a par with the challenge. To gauge the effectiveness of these measures, we have developed a QE impact indicator. The indicator uses a range of monetary and financial variables describing the activation of the various monetary policy transmission mechanisms.
Financial market turbulence that originated in China has led to tighter financial market conditions (lower equities, stronger dollar), which could hamper progress towards the Fed's growth and inflation mandates.
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.
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