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Pound-to-Dollar Rate: FOMC To Keep Hiking Even As Fed Officials Second Guess Inflation Theories

federal reserve exchange rates

Federal Reserver officials are again second guessing what they know about inflation-drivers but, nonetheless, are still seen pushing ahead with a rate increase in December and as many as four hikes in 2018.  

The Dollar eased lower during early trading in London Thursday after failing to gain impetus for another leg higher from Wednesday’s FOMC minutes.

The downward move in the Dollar comes despite Fed officials being seen still pushing ahead with another rate hike in December and around three hikes in 2018.

“The Fed minutes couldn't really add that much to the rate outlook, since we already have a "dot" forecast that shows that all but four FOMC members expect to hike before year end,” says Avery Shenfeld, chief economist at CIBC Capital Markets.

Markets have been pricing almost as many rate hikes as the Fed will be able to push through over the coming quarters and so the risks were to the downside going into the latest meeting minutes. But with the minutes having born out a tale of frustration among Fed officials over the stubbornly low level of US inflation, policymakers may have fueled further reticence among market participants.

“The Fed members discussed some of the puzzles surrounding recently low inflation readings, some of which might be lasting, and it's therefore interesting that they were still generally expecting to carry through with another hike this year,” says Shenfeld.

Most Fed policymakers reaffirmed their faith in the merits of the Phillips Curve, which links inflation to unemployment, suggesting the FOMC remains some way off from a state of panic over the absence of upward pressures on US inflation.

“Many were still worried about the persistence of some factors holding back inflation, a worry that is likely reflected in the more divided opinion about 2018/19 hikes, while only "some" were described as seeing risks of an overshoot inflation,” says Shenfeld.

Fed chair Janet Yellen spoke in late September about the idea that other factors not currently on the radar of central banks could be weighing on inflation. 

“While market headlines are likely to focus on whether the Fed will or won’t hike in Dec, the real story is that ‘many participants’ are concerned that the weak inflation trends are more than just transitory – with structural and persistent factors weighing on US and global inflation,” says Viraj Patel, a strategist at ING Group.

Taken together with the discussion revealed by Wednesday's minutes, Yellen's speech could mean that renewed questions over the underlying drivers of inflation is a topic markets will hear much more about over the coming quarters.

“ING’s Rob Carnell is right by stating that as this is out of the Fed’s control, they could just embrace it by lowering the 2% inflation target – and it’s likely that most economic agents won't really care,” says Patel.

Forecasters at Capital Economics noted after the minutes were released that the latest round of dot plot projections do not take into account the prospect of the economy receiving a fiscal boost over the course of 2018.

“That supports our view the enactment of a modest tax cutting package early next year will ultimately persuade the Fed to hike interest rates four times next year, to between 2.25% and 2.50% by end-2018, whereas the median projection for Fed officials is consistent with three hikes,” says Paul Hollingsworth, chief North American economist at Capital Economics.

But almost all forecasters acknowledge risks to their views on US rates stemming from the possible changeover at the top of the Federal Reserve in February 2018 when Chair Yellen’s term expires.

For an overview of who the candidates are for Fed Chair and an explainer of what each might mean for the Dollar, see our report; Change at the Fed: What Each of the Candidates Could Mean for the US Dollar's Outlook.

Sterling exploited the renewed reticence among Dollar bulls Thursday morning, helping push the Pound-to-Dollar rate up by 0.05% to 1.3242. Meanwhile, the Euro-to-Dollar rate edged downward 0.01% to 1.1863. The US Dollar index was quoted down 0.08% at 92.89.

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