Financial Methods: Higher Rates Begin to Bite

It often takes changes in monetary policy 12 to 18 months (or more) before the full effect is visible in economic data. It has been 18 months since the Fed first began raising interest rates.

The Creighton Economic Forecasting Group at Creighton University conducts a monthly survey of supply managers in nine Midwest states. They use the same methodology as the national Institute for Supply Managers (ISM) survey.

The December survey continued a streak of slowing economic growth due to higher interest rates and energy prices. Over the course of last year, the annual rate of job growth slowed from +1.7% during the first six months, to +0.7% in the last six months.

The good news is that inflationary pressures are easing.

For the third consecutive month, the prices-paid index for the region declined moving to 79.1 from November’s 82.7. While December’s reading still indicates significant inflationary pressures at the commodity and wholesale level, [Creighton University Economics Professor Ernie Goss] said he expects inflationary pressures to weaken in the months ahead as moderating oil prices and higher interest rates move through the economic pipeline.

Goss is also one of the economists that falls into the solid consensus that the Fed has nearly completed its tightening campaign. There could be an ugly market surprise should the Fed continue to tighten longer than expected.

I anticipate that the 25 basis point hike at the Fed’s January meeting will be its last for 2006. Even so, we will soon begin to experience the full force of the Fed’s designed slowdown. The economic deceleration should move the Fed to the sidelines for the first year of the Bernanke Fed.

If we assume a 12-month lag in monetary policy, then the economy has yet to reflect the full impact of last year's rate increases. We will see their effect over the course of 2006.

Creighton Economic Forecasting Group.
Slower Growth For 2006: Higher Interest Rates Will Offset The Opening Of International Markets To U.S. Beef.
January 3, 2006
http://www.outlook-economic.com/RegionalEconomicOutlook/MidAmericanData/MidAmericanRegion.html