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We confirm our call that the FOMC will hike rates by 25 bps at the December FOMC meeting. The October employment report cinched the case for a December liftoff, in our view. Monetary policy will still remain quite accommodative for some time as we see a gently rising rate trajectory with the Fed moving at a gradual pace towards a more normal rate structure.
Our Quantitative Easing impact indicator continued to edge down in October, following the virtually across-the-board deterioration in monetary and financial conditions observed over the summer. The monetary policy transmission channels that most immediately responded to the launch of the policy at the start of the year are those that have deteriorated most.
The meeting of the Bank of England on 5 November proved to be a non-event. The BoE left its monetary policy unchanged. The November Quarterly Inflation Report is dovish and the new projections for inflation suggest that the process of normalisation in monetary policy will come later than was thought back in August. The BoE expects CPI inflation to overshoot the 2% target in two years, which we read as a hawkish signal relative to market interest-rate expectations.
Q3 real GDP growth rose at a 1.5% annual rate, following a 3.9% increase in Q2, while the core PCE deflator slowed to a 1.3% rate in Q3. Domestic final sales grew at a healthy 3.0% pace led by a solid 3.2% advance in consumer spending. The deceleration in growth reflected an inventory correction that trimmed 1.44% points from Q3 growth. We see GDP growth reaccelerating in Q4 as consumer spending powers ahead and the inventory correction will be largely completed.
The fed funds target range was maintained at 0 to 0.25% as widely expected. And the FOMC guidance continues to anticipate that "it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term."
No Fed tightening is expected at this week's FOMC meeting even though it was seen by some policymakers as a close call in September. The October meeting has no Summary of Economic Projections (SEP) or scheduled press conference. Financial markets have priced out a rate increase at next week's meeting. Disappointing payroll gains over the past two months, weaker industrial production and some moderation in the strength of consumer spending argue for a cautious approach to rate normalization.
Mario Draghi rekindled the accommodative stance, pointing to another round of stimulus as early as December. The ECB is ready to accommodate further using "a whole menu of policy instruments". Most importantly, Mario Draghi presented a deposit rate cut as a possibility, going back on his previous declaration about the "effective lower bound" reached by the ECB's rates.
Short-term data suggests growth is slowing in the second half of the year. We have cut our growth forecasts by 0.1 ppt on average per quarter (to 0.5% QoQ in Q3 and Q4). However, solid fundamentals for domestic demand allow us to maintain our relatively positive view on the UK economy. Growth is likely to remain driven primarily by consumer spending, housing and business investment.
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.
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