• Increased concerns from weaker business expectations, tight labor markets along with low productivity growth
• Inflation risk remains the predominant concern
• Fed rates will remain steady at 5.25%

Greater uncertainty from downside risks to growth and upside to inflation

In the intermeeting period the outlook deteriorated for both growth and inflation. The staff forecast marked down Q107 GDP growth in response to weaker-than-expected business spending and federal defense purchases. Economic activity was likely to be affected by higher oil prices, lower equity prices, and pressures from the subprime mortgage sector. The housing drag was expected to continue from further inventory adjustment and tighter credit standards in the subprime market. As a result, expectations on GDP growth for the remainder of 2007 and 2008 changed from ???to a level that was close to the staff's estimate of potential output growth??? to ???a rate a little below that of the economy??™s long-run potential.??? The estimate for headline inflation increased as a result of higher energy prices while that for core inflation remained unchanged.

Discussion reflected increasing concerns on the downside risks to growth from ???surprisingly weak??? investment growth despite strong fundamentals, and the possibility that this trend might be persistent if businesses are expending ???quite modest gains in sales.??? Members indicated that the risk that core inflation ???would fail to moderate as expected??? remained as their predominant concern. The latter judgment reflects uncertainty ???on whether core inflation was on the expected downward path??? given high recent readings of inflation and low on productivity growth, along with elevated energy prices. Although FOMC judged that ???further policy firming might prove necessary??? it decided that the statement ???should no longer cite only the possibility of further firming???.

FOMC clearly biased to hold rates steady at 5.25%

As we anticipated, minutes confirm that FOMC??™s increased uncertainty was led from greater concerns on the downside risks to growth and upside risks to core inflation. Worries arose from the possibility of persistently sluggish investment spending and the risk that labor costs might increase more rapidly. Minutes are consistent with our perspective of an extended pause at 5.25% throughout 2007 given mixed data and increased uncertainty, and signal that neither rate cuts nor hikes are likely considering that core inflation remains high and sticky to the upside, while downside risks to growth have risen.