NEWS / Foreign Exchange

The beige book message is clear and in line with our current expectations

The beige book message is clear and in line with our current expectations, supporting a scenario of moderation rather than contraction in economic activity during the third quarter of 2007. The future economic outlook is slightly improving in October following a rather pessimistic September, when many market participants had concerns about the economy??™s ability to absorb the spillover effects of the housing slump as well as the efficacy of the Fed previous stand regarding monetary policy. One of the strongest resiliency factors is the labor market, which continues showing signs of tightness in various areas of the U.S. and, also, maintains upward pressures on wages and salaries. The unemployment rate in September remained low at 4.7 percent, but increased a tenth of percent from 4.6 percent in August. However, employment levels for professional services and leisure and hospitality are at historically high levels; we expect labor market tightness in the professional service sector, specifically highly skilled workers, to remain in the intermediate term. Moreover, worker shortages in this sector could induce significant wage increases. In addition, the high level of resource utilization continued during September maintaining the level observed in the previous three months. We anticipate that the slower pace of economic growth will tend to generate some slack over time.
Residential real estate markets continued the downward trend, as home sales decline further. Lenders reported a tightening of credit standards for real estate, as delinquencies continue growing and credit quality shows signs of deterioration. For home buyers, securing financing and / or selling their current home is increasingly hard. New and existing homes inventories are raising and builders continued to curb their future outlook for new home construction. Rising inventories of existing homes continue adding uncertainty to the overall health of the housing market. On the other hand, commercial real estate market remained solid and rental rates were firm in various markets across the U.S.
Another resiliency factor is the inflation reading for September; overall, consumer prices appeared to be contained and increased at a seasonally adjusted annual rate of 1.0 percent in the third quarter of 2007 compared to 4.7 and 5.2 percent during the first and second quarters of 2007, respectively. During September consumer prices were 2.8 percent higher than a year ago, before seasonal adjustment. This is the largest 12-month increase since March, when the CPI-U reached 2.8 percent. On a seasonally adjusted basis, the CPI-U increased 0.3 percent in September following a 0.1 percent decline in August, according to the Bureau of Labor and Statistics latest release. Also, the CPI-W (Index for Urban Wage Earners) increased by 0.3 percent in September, before seasonal adjustment, and it was 2.8 percent higher than a year ago. Core prices were up 2.1 percent on a year-over-year basis. The index for energy rose by 0.3 in September following a decline in each of the three preceding months. The index for energy services rose by 0.1 percent and the food index rose by 0.5 percent, one of the largest contributors to overall inflation in September. The consumer price index excluding food and energy increased by 2.3 percent during the first three quarters of 2007, compared to a 2.6 percent increase during the same quarters of 2006. This deceleration on core inflation readings is, mainly, due to a lower index for shelter and the significant reduction on the index for apparel during the first nine months of 2007. Overall, the CPI-U is gaining some momentum but core inflation appears to be contained. We believe that CORE inflation contains more information about future Fed actions, and is in line with our expectations of future rate cuts as the upside risk on inflation is offset by the downside risk on growth. We expect core inflation to be within the Fed ???comfort zone??? in 4Q07. Thus, we maintain our forecast for 2007-08 of 2.3% and 2.1% annual averages for the CPI-U consumer price index and core inflation respectively.
At the same time, the PPI core inflation rose by 0.1 percent, which is in line with our expectations of controlled inflationary pressures. For overall producer prices, it was the largest gain of the year, since February??™s reading of 1.2 percent. Prices paid for intermediate goods increased by 0.4 percent after a 1.2 percent drop in August and the crude goods index rose 0.1 percent after a 3.0 percent fall the previous month. We expect the Fed to cut the rate by 50 bp by year end, according with a scenario of growth deceleration and a continuation of adverse financial market conditions.