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The Manager of the System Open Market Account reported on recent
developments in foreign exchange markets. There were no open market
operations in foreign currencies for the System's account in the period
since the previous meeting. The Manager also reported on developments in
domestic financial markets and on System open market transactions in
government securities and federal agency obligations during the period
since the previous meeting. By unanimous vote, the Committee ratified
these transactions.
By unanimous vote, the Committee voted to extend for one year beginning
in mid-December 2005 the reciprocal currency ("swap") arrangements with
the Bank of Canada and the Banco de Mexico. The arrangement with the Bank
of Canada is in the amount of $2 billion equivalent and that with the
Banco de Mexico in the amount of $3 billion equivalent. Both arrangements
are associated with the Federal Reserve's participation in the North
American Framework Agreement of 1994. The vote to renew the System's
participation in the swap arrangements maturing in December was taken at
this meeting because of the provision that each party must provide six
months prior notice of an intention to terminate its participation.
The information received at this meeting suggested that the growth of
economic activity had unexpectedly moderated during the first quarter from
the rapid pace seen during the second half of 2004. Gains in private
payroll employment over the first quarter were similar to the average for
the second half of 2004 but weakened in March, and manufacturing
production rose only a little, on balance, over February and March.
Consumers appeared to have turned somewhat cautious in their spending,
likely a reflection of higher energy prices. Housing starts fell in March
after a sustained stretch of very high readings, but home sales continued
at a rapid rate throughout the quarter. Growth of capital spending, while
strong in the first quarter, was down from the brisk rates of previous
quarters. Sharp increases in energy prices pushed up headline inflation,
and core measures were also somewhat elevated. Labor costs, however,
advanced at a moderate rate. Employment continued to expand in March,
although the increase was less than the strong advance in February.
Employment declined in manufacturing, retail trade, and temporary help
services, but most other sectors registered gains. The average workweek
remained at its recent level, and aggregate hours posted a small gain. The
unemployment rate moved down to 5.2 percent in March. Also suggesting a
gradual erosion of slack in labor markets were surveys indicating that
some employers were finding some jobs requiring special skills harder to
fill and that households were experiencing increases in job availability.
Nevertheless, survey measures of expected conditions in labor markets
softened somewhat in the early months of the year, and the labor market
participation rate remained low in March.
Industrial production continued to expand in the first quarter, but the
pace was slower than in the final months of 2004. Gains were restrained by
a decline in manufacturing output, particularly for motor vehicles and
parts, and by a reduction in energy generation at utilities, which was
held down by unseasonably warm weather early in the year. Mining output,
however, accelerated, as did production in the business equipment and
defense and space equipment industries. Capacity utilization in
manufacturing edged up on average in the first quarter, but moved down in
March and remained a bit below its thirty-year average.
Consumer spending advanced solidly in the first quarter despite some
slowing in automobile sales. However, much of that strength was registered
early in the quarter, and spending in March was subdued. Measures of
consumer confidence declined in the early months of the year but remained
well above the lows of two years ago. Other factors underlying consumer
spending also remained favorable: Real wages and salaries continued to
rise, and the ratio of wealth to income remained high, although it was
down a bit because of a decline in equity prices. The personal saving rate
stayed low over the first quarter of the year.
Housing starts slowed in March, after exceptional strength in the prior
two months. However, a substantial increase in the level of permits in
March suggested that starts likely turned back up in April. A similar
pattern was observed in the multifamily sector. The thirty-year mortgage
rate in the first quarter stayed in a range around its average level for
the past two years. Sales of existing homes were rapid throughout the
quarter, and sales of new homes rose to another record level in March.
House prices continued to rise rapidly over the first quarter, although
recent data suggested some slowing.
Growth of business spending on equipment and software moderated
substantially in the first quarter from the very high rates of last year,
but appeared to retain considerable momentum; strong gains occurred in all
major categories except motor vehicles. This performance reflected
favorable underlying fundamentals, including solid growth in business
output, strong retained earnings, high levels of liquid assets, and
favorable borrowing conditions in the form of low interest rates and
narrow risk spreads in bond and loan markets. At the same time,
construction of nonresidential structures remained quite subdued. Over the
first quarter, outlays for manufacturing facilities picked up a bit, but
those for office buildings stayed low despite some declines in the office
vacancy rate, and spending on commercial structures fell.
Nonfarm inventories accumulated in the first two months of the year at
a much faster rate than in the preceding quarter, prompting a small
increase in inventory-sales ratios. Inventory gains were especially strong
early in the quarter and were concentrated in the manufacturing sector.
The U.S. international trade deficit widened in February as exports
held steady. The value of imported oil jumped sharply, and nonoil imports
also rose. Economic indicators for major foreign industrial countries
suggested some slowing of growth late in the quarter after a pickup
earlier in the year. In Japan, industrial production rose briskly in
January before falling back; the euro-area industrial sector evidenced a
similar pattern. By contrast, economic activity in China and other
developing countries showed greater buoyancy. Consumer price inflation
abroad remained subdued.
U.S. consumer price inflation firmed in recent months as energy prices
rose sharply. Core consumer prices also rose a bit more rapidly recently,
but the increase over the twelve months ending in March was little
different than over the year-earlier period. According to survey
information, expectations of near-term inflation picked up in March,
consistent with the increase in energy prices. As for labor costs, the
employment cost index for private industry decelerated over the first
quarter from an already moderate pace. The slowing occurred in both the
wages and salaries component and the benefits component and was fairly
widespread across industry groups.
At its March meeting, the Federal Open Market Committee decided to
increase the target level of the federal funds rate 25 basis points, to
2-3/4 percent. In its accompanying statement, the Committee expressed its
perception that, with appropriate monetary policy action, the upside and
downside risks to the attainment of both sustainable growth and price
stability should be kept roughly equal. The Committee also noted that
economic output continued to grow at a solid pace despite the rise in
energy prices and that labor market conditions continued to improve
gradually. While pressures on inflation had picked up in recent months and
pricing power was more evident, longer-term inflation expectations
remained well contained. In these circumstances, the Committee believed
that policy accommodation could be removed at a pace that would likely be
measured but noted that it would respond to changes in economic prospects
as needed to fulfill its obligation to maintain price stability.
The FOMC's decision in March to raise the intended level of the federal
funds rate 25 basis points was fully anticipated by the market, as were
its retention in the accompanying statement of the "measured pace"
language and its assessment that the risks to price stability and
sustainable economic growth were balanced. Interest rates, however, rose,
reportedly in response to the statement's references to increased price
pressures and to more evident pricing power as well as to the Committee's
conditioning of its risk assessment on "appropriate monetary policy
action." Interest rates rose further the next day following the release of
a larger-than-expected increase in the CPI for February. Over subsequent
weeks, however, these increases were more than reversed by
weaker-than-expected data on consumer spending, consumer sentiment, and
output. Further downward pressure on interest rates was exerted by the
market's response to the release of the minutes of the March meeting, as
attention focused on the reference to Committee members' judgment that an
accelerated path of policy tightening was not necessary at that time.
Despite generally good first-quarter earnings reports, equity indexes
moved down considerably in response to the signs of weaker economic
growth. In foreign exchange markets, the dollar rose on balance,
apparently due, in part, to disappointing news on employment and output
abroad.
M2 expanded in March and April at about the same sluggish pace as it
did earlier in the year. The growth of M2 continued to be restrained by
increases in its opportunity cost resulting from rising short-term
interest rates. Rates paid on its liquid components particularly lagged
increases in market rates.
Partly in response to the receipt of weaker-than-expected data for
spending and output in the first quarter, the staff marked down somewhat
its forecast of economic growth for 2005 and 2006. Even so, the economy
was seen as retaining considerable momentum, and growth was expected to
pick up some after the first quarter, paced by business spending on
equipment and software. Consumption expenditures were seen as likely to
expand at a moderate rate and residential investment to slow. With exports
forecast to expand a bit more rapidly than imports, the arithmetic net
drag on the economy from trade was expected to lessen. Fiscal policy was
expected to provide a more moderate impetus to growth this year and next,
following the substantial boost estimated for earlier years. Although
economic growth was projected to run a bit above the staff's estimate of
the economy's potential, the unemployment rate was projected to hold
around its current level with improvements in job prospects expected to
lure more workers back into the labor force. Inflation was projected to
edge lower over the rest of the year and into 2006, reflecting the
attenuation of the impact of higher energy prices and the effects of a
slowed rate of growth of import prices and remaining slack in resource
markets.
In their discussion of current conditions and the economic outlook,
meeting participants observed that incoming data over the intermeeting
period hinted at possible upside risks for inflation and downside risks
for economic growth. Earlier increases in energy prices seemed to be an
important factor contributing to an uptick in core inflation and a slower
pace of economic activity. With energy prices leveling out more recently,
however, and the behavior of compensation suggesting a lack of pressure in
labor markets, underlying inflation appeared to remain contained. The
weakness in spending was widespread and could not be completely dismissed,
but it had appeared only very recently and could be a product of the
inherent noisiness of high-frequency economic data. On balance, economic
fundamentals including low interest rates, robust underlying productivity
growth, and strengthened business balance sheets were expected to support
economic growth at a pace sufficient to gradually eliminate remaining
slack in resource utilization. Although the economic outlook generally
seemed favorable, there was also broad recognition of greater uncertainty
attending the outlook for both inflation and output growth.
Capital expenditures advanced briskly over the first quarter, but at a
pace significantly below that registered over the latter half of last
year. To some extent, businesses probably had pulled capital outlays
forward from this year into 2004 to benefit from the partial-expensing tax
provision that expired at year-end, but the unexpected weakness in capital
goods orders for February and March seemed hard to attribute to this
factor alone. In addition, the prolonged period of elevated spot energy
prices, the sense supported by futures markets that these higher prices
may persist for some time, and the heightened uncertainty about energy
prices going forward, together may have left businesses less confident
about the future and wary of longer-term commitments such as expanding
plant capacity or taking on new workers. A less buoyant and less certain
economic outlook seemed apparent in financial markets as well, where
equity prices had fallen and risk spreads had widened. On balance, though,
these financial developments did not appear to signal the onset of a sharp
retrenchment in investors' willingness to bear risk, and capital
expenditures were seen as likely to remain quite robust, spurred by strong
economic fundamentals that included elevated profits, opportunities to
raise efficiency by utilizing new technologies, a low cost of capital, and
strong corporate balance sheets. Indeed, a substantial weakening in
business investment in an environment with such favorable fundamentals
would be at odds with the historical record.
Incoming data for the household sector were viewed as mixed. Higher
gasoline prices seemed to be sapping consumer confidence and consumer
spending. The pace of consumption growth had fallen off appreciably toward
the end of the first quarter, and some participants worried about the
potential for continued sluggishness in consumer spending if increasingly
cautious households sought to raise their saving rate rapidly. On balance,
though, strong income growth and low interest rates augured well for
household spending. Although housing starts had dropped of late, home
sales and other indicators of activity in the residential real estate
market remained at very high levels. House price appreciation was expected
to moderate over coming quarters, but a number of local real estate
markets were still regarded as "hot," with signs of possible speculative
excesses in some areas.
The deceleration in final sales over the first quarter had been
accompanied by a sizable accumulation of businesses inventories. The
available data suggested that stocks had accumulated in a variety of
industries, but particularly in the motor vehicle sector where the
inventory of new autos had moved appreciably higher. Although difficult to
judge, the inventory buildup was not regarded as likely to have major
implications for aggregate manufacturing beyond some modest production
cutbacks in the current quarter.
A relatively high proportion of demand had continued to be met by
imports. Some concern was expressed that incoming data suggested weaker
growth in some of our major trading partners, which posed a downside risk
to forecasts for U.S. exports. Moreover, advances in domestic income were
expected to contribute to brisk growth in imports. Looking ahead, the U.S.
economy was expected to continue to run quite substantial current account
deficits, although the impact of past dollar depreciation should work to
boost exports and slow the rise in imports to some extent.
Recent energy price developments garnered considerable attention.
Declines in energy prices in recent weeks were viewed as welcome, but
participants noted that far-dated futures prices for oil remained quite
elevated and that persistently high energy prices could trigger a range of
deleterious effects on the economy. High energy prices appeared to be
taking a toll on household and business confidence and might be beginning
to crimp corporate profits. In some cases, firms seemed to be more
successfully passing on energy costs to their customers. Indeed, some
portion of recent elevated inflation readings probably represented, at
least partly, such pass-through effects from higher energy costs. However,
while pass-through effects could leave the overall price level higher,
their impact on inflation should fade over time, as long as inflation
expectations remain well contained. Still, considerable uncertainty
surrounded the degree of pass-through from energy prices to core consumer
prices, and pass-through effects might be more pronounced when energy
price increases were perceived as more likely to be permanent.
Persistently high energy prices were mentioned as a factor that could trim
the level of potential output to a small degree over time, possibly
contributing to additional upward pressure on consumer prices at the
margin.
Participants voiced concerns about recent price trends; they expected
inflation to remain contained but also perceived that the risks to that
inflation outlook now might be skewed somewhat to the upside. Core
measures of price inflation had moved up over recent quarters and
particularly so over the last few months. A discernable upcreep was
apparent in survey measures of short- and, to a limited extent, long-term
inflation expectations over recent months. Moreover, there were risks that
the relative stability of long-term survey measures of inflation
expectations could simply reflect lags in households' perceptions of
changing economic prospects. The success that some businesses seemed to be
encountering in passing through cost increases raised the possibility that
competitive pressures and resource slack were exerting somewhat less
restraint on inflation than had been anticipated.
However, available indicators of wages and benefits had registered only
modest growth, suggesting to many that some slack in labor markets
persisted. Moreover, market measures of inflation compensation had ebbed
in recent weeks, and survey measures of long-term inflation expectations,
albeit a touch higher of late, remained in the broad range of recent
years. Along with energy prices, import and materials prices apparently
had contributed to the recent uptick in inflation, and pressures on
inflation stemming from these three sources were expected to lessen over
coming quarters. On balance, measures of core inflation were thought
likely to remain in check over the remainder of this year and next.
In the Committee's discussion of monetary policy for the intermeeting
period, all members favored raising the target federal funds rate 25 basis
points to 3 percent at this meeting. Although downside risks to
sustainable growth had become more evident, most members regarded the
recent slower growth of economic activity as likely to be transitory. In
this regard, the ability of the U.S. economy to withstand significant
shocks over recent years buttressed the view that policymakers should not
overreact to a comparatively small number of disappointing indicators,
especially when economic fundamentals appeared to remain quite supportive
of continued solid expansion. To be sure, the Committee had raised its
federal funds rate target appreciably over the past year, and, in the view
of a few members, a larger-than-expected moderation of aggregate demand in
response to this cumulative policy action could not be ruled out. However,
all members regarded the stance of policy as accommodative and judged that
the current level of short-term rates remained too low to be consistent
with sustainable growth and stable prices in the long run. Against the
backdrop of the recent uptick in core inflation and in some measures of
inflation expectations, members agreed that they should continue along the
course of removing policy accommodation at a measured pace conditional on
the outlook for inflation and economic growth.
In discussing the statement to be released after the meeting, members
agreed that it was appropriate to acknowledge that rising energy prices
seemed to have spurred an increase in core measures of inflation by
dropping the reference from the March statement indicating that "The rise
in energy prices, however, has not notably fed through to core consumer
prices." They likewise all agreed that mention should be made that, on
balance, longer-term inflation expectations remained well contained.
Regarding the risks to sustainable growth and price stability, some
members noted that the risk assessment conditioned on "appropriate policy"
no longer seemed to convey useful information regarding the Committee's
economic and policy outlook. Although some members noted that a case could
be made that the risks to inflation were now somewhat skewed to the upside
and those to sustainable economic growth perhaps to the downside, the most
likely outcome remained one of stable prices and sustainable growth, and
the Committee agreed that it should retain a balanced assessment of risks
conditional on appropriate policy.
For many, heightened economic uncertainty in the current environment
implied greater uncertainty about the range of possible policy outcomes
and placed a premium on flexibility in setting policy at upcoming
meetings. Some members commented that this greater uncertainty called for
eliminating or paring back forward-looking language from the statement--if
not at this meeting, then fairly soon. In the event, most members viewed
the forward-looking language in the statement--including the
characterization of the stance of policy as accommodative as well as the
judgment that policy accommodation could be removed at a pace that is
"likely to be measured"--as a reasonable characterization of the policy
stance and its likely evolution over time. Moreover, a number remarked
that the language in its current form was clearly conditioned on economic
developments and therefore would not stand in the way of either a pause or
a step-up in policy firming depending on events. In the end, all members
agreed to retain the forward-looking language.
At the conclusion of the discussion, the Committee voted to authorize
and direct the Federal Reserve Bank of New York, until it was instructed
otherwise, to execute transactions in the System Account in accordance
with the following domestic policy directive:
"The Federal Open Market Committee seeks monetary and financial
conditions that will foster price stability and promote sustainable
growth in output. To further its long-run objectives, the Committee in
the immediate future seeks conditions in reserve markets consistent with
increasing the federal funds rate to an average of around 3 percent."
The vote encompassed approval of the paragraph below for
inclusion in the statement to be released shortly after the meeting:
"The Committee perceives that, with appropriate monetary
policy action, the upside and downside risks to the attainment of both
sustainable growth and price stability should be kept roughly equal.
With underlying inflation expected to be contained, the Committee
believes that policy accommodation can be removed at a pace that is
likely to be measured. Nonetheless, the Committee will respond to
changes in economic prospects as needed to fulfill its obligation to
maintain price stability."
Votes for this action: Messrs. Greenspan and Geithner,
Ms. Bies, Messrs. Ferguson, Fisher, Gramlich, Kohn, Moskow, Olson,
Santomero, and Stern.
Votes against this action: None.
Absent and not voting: Mr. Bernanke
It was agreed that the next meeting of the Committee would be held on
Wednesday-Thursday, June 29-30, 2005.
The meeting adjourned at 1:25 p.m.
Notation Vote
By notation vote completed on April
11, 2005, the Committee unanimously approved the minutes of the meeting of
the Federal Open Market Committee held on March 22, 2005.
Vincent R. Reinhart
Secretary
Footnote
1. Secretary's note: Advice had been received
that Richard W. Fisher had been elected by the directors of the Federal
Reserve Banks of Atlanta, Dallas, and St. Louis, as a member of the
Federal Open Market Committee for the period commencing April 4, 2005, and
that he had executed his oath of office. Return
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