Lively debate and 'hawkish hold' seen from Fed

September 16, 2016 10:28 AM EDT

The United States Federal Reserve Board building is shown in Washington October 28, 2014. REUTERS/Gary Cameron


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By Philip Blenkinsop

BRUSSELS (Reuters) - The Federal Reserve is set for a lively debate in the coming week and could give a clear signal of an interest rate rise to come even if it follows market expectations for a pause this month.

Both the European Central Bank and Britain's Bank of England kept monetary policy unchanged this month, although both with a bias towards further easing action later in the year.

The Fed is expected to follow suit, but with a bias in the opposite direction.

Atlanta Federal Reserve Bank president Dennis Lockhart, viewed as a centrist voice at the Fed, said in the past week that current economic conditions warranted serious debate.

"If 1.6 percent inflation and 4.9 percent unemployment were all you knew about the economy, would you consider a policy setting one tick above the zero lower bound still appropriate?" he said, referring to the core PCE price index, the Fed's preferred inflation measure.

"I think circumstances call for a lively discussion next week," he continued.

Economists polled by Reuters are increasingly expecting an interest rate increase this year, but only in December.

The Federal Reserve's Open Market Committee, which last raised borrowing costs in December 2015 to end seven years of near-zero rates, meets on Sept. 20-21, with a news conference by chair Janet Yellen due on the Wednesday.

DOVISH HIKE VS HAWKISH HOLD

Several Fed officials have said strong payrolls numbers - averaging well over 200,000 in the last three months - are cause for action as early as September.

However, data in recent weeks have shown signs of weakness, including the ISM surveys showing a decline in new orders and production in U.S. factories in August and service sector activity at a six and a half year low.

The past week's data included retail sales falling by more than expected last month and producer prices, a sign of future inflation, unchanged.

"The general tone of activity data over the last two weeks is not really enough to swing the doubters into rate hike territory," said James Knightley, senior economist at ING. "If activity is not strong and inflation is non-existent then it seems just a little bit tricky to justify higher rates."

Fed Governor Lael Brainard also hardened the view that the Fed will leave rates unchanged by saying that the central bank should avoid removing support too quickly.

Brainard said that she wanted to see a stronger trend in U.S. consumer spending and evidence of rising inflation before the Fed raises rates, and that the United States still looked vulnerable to economic weakness abroad.

Harm Bandholz, chief U.S. economist at UniCredit, said he expected a rate rise soon - but not in the coming week.

"I also think there will be a bit of a compromise, meaning no action but a clear hint... that there will be one hike later this year," he said.

He believes that hint could come in the statement, chair Janet Yellen's comments or in the "dots", indicating FOMC members' view on the key fed funds rate - likely, he said, to show a big majority seeing one hike by the end of 2016.

BNP Paribas, by contrast, says the market has given greater weight to dovish comments because they were more recent and presumes data must be "impeccable" for the Fed to move.

It believes a "dovish hike" is more likely than a "hawkish hold". The former might involve an indication of no further increases this year. A pause, with an upgraded view of the economy, could put the Fed in an awkward position in December if not all data is strong, it suggested.

"What our argument for a September hike boils down to is that if the Fed waits for every little duck to line up in a neat row, it will wait forever," BNP said.

After September, the Fed's policy-setting committee meets on Nov. 1-2, a week before Americans vote for their next president, before its last session of the year on Dec. 13-14.

NEW JAPANESE FOCUS ON NEGATIVE RATES

Japan's central bank will also meet on Tuesday and Wednesday and present an assessment of its ultra-easy monetary policy.

Sources familiar with the Bank of Japan's (BOJ) thinking have said negative interest rates could become the centerpiece of monetary policy, in a shift away from the base money target that has become the focus since 2013.

That would signal that the BOJ's massive economic stimulus thus far, a cornerstone of Prime Minister Shinzo Abe's plan to lift the economy, is close to its limit.

On the data front it is a thin week, although euro zone purchasing managing indexes due on Sept. 23 are among the more closely watched figures, having bumped along in the low 50s for much of the past year.

"Brexit fears haven't really impacted the indexes yet. We see no real reasons for why we'd get a big shift, so more of the same, consistent with modest to mediocre ongoing growth of around one and a bit percent."

(Editing by Hugh Lawson)



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