FYI | Jun 15 2006
By Rudi Filapek-Vandyck
The argument whether central bankers will move official interest rates too high again this cycle is a no brainer over at Singapore based DBS Group. The group’s economists already regard the current 5% Fed Funds as restrictive, so no guessing what they think might happen if the Fed raises again at the June 29 meeting.
Economic growth in the US is going to decelerate from here on, DBS believes, and by the last quarter of 2006 GDP growth will not be higher than 1.7%.
What this amounts to, in essence, is that the world’s largest economy will experience "a mild case of stagflation" over the next few months. Expect inflation to abate after that, but slower economic growth is likely to stay.
Imagine what will happen to this scenario when the Fed decides to hike interest rates again at its September meeting.
DBS would argue against both decisions, but acknowledges that a new chairman has to make his mark and thus Ben Bernanke will try to look as decisive in fighting inflation as possible. The economists believe investors better consider another interest rate hike by 25 basis points at the upcoming June meeting as a given.
On top of this, chances of another hike have increased since inflation data remains out of the Fed’s comfort zone.
All this will come back to Bernanke & Co in early 2007, DBS suggests. By then it will have become clear that inflation is no longer a genuine threat while economic growth is closer to a turtle’s pace than to the hare’s, and therefore interest rates will need to be cut.
DBS currently predicts US interest rates to fall back to 4.75%, implying two cuts in the first two quarters of 2007.
The economists do not elaborate on how a possible Fed interest rate hike beyond June this year will impact on their outlook.