FOMC Minutes

June 27-28, 2007

A meeting of the Federal Open Market Committee was held in the offices of the Board of Governors

of the Federal Reserve System in Washington, D.C., on Wednesday, June 27, 2007 at 2:00 p.m. and

continued on Thursday, June 28, 2007 at 9:00 a.m.

Present:

Mr. Bernanke, Chairman

Mr. Geithner, Vice Chairman

Mr. Hoenig

Mr. Kohn

Mr. Kroszner

Ms. Minehan

Mr. Mishkin

Mr. Moskow

Mr. Poole

Mr. Warsh

Mr. Fisher, Ms. Pianalto, and Messrs. Plosser and Stern, Alternate Members of the

Federal Open Market Committee

Messrs. Lacker and Lockhart, and Ms. Yellen, Presidents of the Federal Reserve

Banks of Richmond, Atlanta, and San Francisco, respectively

Mr. Reinhart, Secretary and Economist

Ms. Smith, Assistant Secretary

Mr. Skidmore, Assistant Secretary

Mr. Alvarez, General Counsel

Ms. Johnson, Economist

Mr. Stockton, Economist

Messrs. Connors, Evans, Fuhrer, Madigan, Rasche, Sellon, Slifman, and Wilcox,

Associate Economists

Mr. Dudley, Manager, System Open Market Account

Messrs. Clouse and English, Associate Directors, Division of Monetary Affairs,

Board of Governors

Ms. Liang and Mr. Struckmeyer, Associate Directors, Division of Research and

Statistics, Board of Governors

Messrs. Leahy and Wascher, Deputy Associate Directors, Divisions of International

Finance and Research and Statistics, respectively, Board of Governors

Mr. Dale, Senior Adviser, Division of Monetary Affairs, Board of Governors

Mr. Blanchard, Assistant to the Board, Office of Board Members, Board of

Governors

Mr. Gross, 1 Special Assistant to the Board, Office of Board Members, Board of

Governors

Mr. Small, Project Manager, Division of Monetary Affairs, Board of Governors

Mr. Ahmed 2 and Ms. Kusko, 2 Senior Economists, Divisions of International

Finance and Research and Statistics, respectively, Board of Governors

Mr. Luecke, Senior Financial Analyst, Division of Monetary Affairs, Board of

Governors

Ms. Beechey and Mr. Natalucci, 2 Economists, Division of Monetary Affairs, Board

of Governors

Ms. Low, Open Market Secretariat Specialist, Division of Monetary Affairs, Board of

Governors

Mr. Moore, First Vice President, Federal Reserve Bank of Cleveland

Mr. Rosenblum, Executive Vice President, Federal Reserve Bank of Dallas

Ms. Mester, Messrs. Sniderman, Weinberg, and Williams, Senior Vice Presidents,

Federal Reserve Banks of Philadelphia, Cleveland, Richmond, and San Francisco,

respectively

Ms. McLaughlin and Mr. Tallman, Vice Presidents, Federal Reserve Banks of New

York and Atlanta, respectively

Ms. McConnell, Assistant Vice President, Federal Reserve Bank of New York

Mr. Weber, Senior Research Officer, Federal Reserve Bank of Minneapolis

1. Attended portion of the meeting relating to monetary policy communications.

2. Attended portion of the meeting relating to the economic outlook and monetary

policy discussion.

The information reviewed at the June meeting suggested that the expansion of economic

activity rebounded in the second quarter from its subpar pace in the first quarter. Upswings

in net exports and inventory investment were expected to contribute importantly to the rise in

real GDP. Consumer spending appeared to have slowed from its rapid pace earlier in the

year, while business fixed investment continued to rise at a modest rate. Residential

construction remained weak as builders worked further to clear high inventories of unsold

homes. Sharp increases in energy prices drove up overall inflation in April and appeared to

have done so again in May; core inflation seemed to have remained subdued.

Employment continued to rise at a moderate pace; the average monthly increase in payroll

employment in April and May was a little below that of the first quarter. In May,

employment was boosted by strong hiring in the service sector, but the manufacturing and

retail sectors continued to shed jobs. Larger payrolls and a slightly longer average workweek

in May led to an increase in aggregate hours; the unemployment rate held steady at 4.5

percent.

Industrial production increased modestly in April and May after having been little changed in

the first quarter when some manufacturers restrained production to cope with a buildup in

inventories. Manufacturing output edged up in recent months, reflecting increases in the

output of light motor vehicles, other consumer durable goods, construction supplies, and

durable materials. The production of high-tech industries also rose, albeit at a relatively

sluggish pace compared with the brisk expansion seen around the turn of the year. Capacity

utilization in the manufacturing sector in May was close to its long-run average and slightly

below its level one year earlier.

The pace of real consumer spending appeared to have slowed somewhat in the second quarter

after substantial increases late last year and early this year. The deceleration primarily

reflected a flattening out of outlays for goods in recent months; spending on services

continued to rise at a solid pace for the quarter as a whole, although the monthly pattern was

affected by weather-related swings in outlays on energy services. The determinants of

household spending were broadly supportive. Real disposable personal income rose at a

moderate pace, on average, in the first four months of the year, boosted not only by ongoing

gains in wages and salaries, but also by unusually large bonus payments and stock option

exercises in the first quarter. Although the household wealth-to-income ratio ticked down in

the first quarter with the stock market up only a little and house prices remaining soft, the

increase in stock prices in the second quarter likely made up much of the lost ground.

Elevated inventories of unsold new homes continued to weigh on residential construction

activity. In May, single-family housing starts declined, and adjusted permit issuance for the

single-family sector stepped down further, indicating that builders were intending to slow

further the pace of new construction. The monthly readings on sales of new and existing

homes through May had fluctuated around levels lower than the average over the second half

of 2006. Some, though not all, of this weakening in home sales was likely related to the

tightening of lending standards for nonprime borrowers that began in February. Even though

the inventory of new homes for sale ticked down in May, the months’ supply in May

remained noticeably above its level in late 2006. According to OFHEO’s purchase-only

price index for existing homes, house-price appreciation continued to slow in the first

quarter.

Outlays for nonresidential construction appeared to have remained robust early in the second

quarter. Business spending on equipment and software in recent months appeared to be

about unchanged from the first quarter, although the softness was largely confined to outlays

for transportation equipment. Shipments and orders for items other than transportation

moved up markedly in March and April after weakness in earlier months, and, even with the

small declines in May, the data pointed to a healthy rise in outlays in the second quarter. In

particular, real spending on equipment other than high-tech and transportation seemed to be

rebounding after sizable declines over the previous two quarters. After a surge in outlays on

computers in the first quarter, spending on high-tech equipment appeared to be rising at a

more modest pace in April and May. In contrast, spending on transportation equipment

declined significantly. Purchases of medium and heavy trucks dropped further in May,

continuing to reflect the payback from sales that were pulled forward into 2005 and 2006 in

anticipation of tighter emissions standards that took effect in January. New orders for trucks

picked up in May, albeit from very low levels. Shipments data indicated that spending on

aircraft dropped back from the elevated level in the first quarter. The downtrend in the cost

of capital was likely curtailed in recent weeks by the rise in corporate bond rates.

Nonetheless, firms retained ample cash in reserve to finance investment.

Real nonfarm inventory investment excluding motor vehicles slowed appreciably in the first

quarter of 2007, as firms in most industries appeared to have made considerable progress in

addressing the inventory overhangs that developed in 2006. The adjustment apparently

continued into the second quarter, as the ratio of inventories to sales for manufacturing and

trade excluding motor vehicles ticked down further in April after a March decline.

Inventories of light motor vehicles, which were pared down to more comfortable levels

during the first quarter, continued to edge lower through May. Indeed, the inventory

adjustment reached the point that, for the third month in a row, the May survey of purchasing

managers indicated that, on net, more firms viewed their customers’ inventory levels as too

low rather than too high.

After no change between the fourth quarter and first quarter, the U.S. international trade

deficit narrowed in April from its March level. The recent narrowing reflected a steep

decline in many categories of goods imports and a modest increase in exports, especially of

agricultural products. Nominal imports of petroleum were flat in April after surging in

March despite steady increases in the price of imported oil.

Economic activity in advanced foreign economies appeared to have grown at a solid rate in

the first quarter. Economic growth in Canada rebounded sharply from a disappointing fourth

quarter, and growth picked up in the United Kingdom, owing primarily to a robust expansion

in the service sector. In the euro area, export growth in the first quarter slowed from its rapid

fourth-quarter pace, and the hike in the German value-added tax likely temporarily depressed

first-quarter consumption growth Consumer spending showed signs of recovering in recent

months, and overall, economic conditions in the euro area remained solid. In Japan, recent

data suggested that growth in the second quarter had moderated from the vigorous firstquarter pace, with public spending and net exports likely sources of weakness. Recent data

indicated that economic activity in emerging-market economies remained strong. Growth in

China and India appeared to have moderated somewhat from the very high rates of the first

quarter. In Latin America, indicators for Mexico suggested some recovery from the marked

slowdown of the previous few quarters, while growth in Argentina and Brazil appeared to

pick up as well.

Headline consumer price inflation stepped up in recent months, driven by large increases in

the index for energy. However, readings on core inflation had declined. Core PCE prices

rose 0.1 percent in April and were estimated to have posted a similar, modest increase in

May. The recent readings had been held down, in part, by declines in volatile categories such

as apparel and tobacco products that were likely to prove transitory; the rent components had

also decelerated. The twelve-month change in core PCE prices in May was expected to be

lower than the increase over the year-earlier period; however, over that longer period, the

decline in core PCE inflation was almost entirely the result of a slowing in its nonmarket

component. Household surveys conducted in early June indicated that the median

expectation for year-ahead inflation increased further, consistent with the energy-driven

acceleration in overall consumer prices in recent months. After edging higher in April and

May, median expectations of longer-term inflation fell back in June and remained in the

narrow range seen over the past two years. The twelve-month change in average hourly

earnings for production or nonsupervisory workers edged lower in recent months.

At its May meeting, the Federal Open Market Committee (FOMC) maintained its target for

the federal funds rate at 5-1/4 percent. The Committee’s accompanying statement noted that

economic growth slowed in the first part of the year and that the adjustment in the housing

sector was ongoing. Nevertheless, the economy seemed likely to expand at a moderate pace

over coming quarters. Core inflation remained somewhat elevated. Although inflation

pressures seemed likely to moderate over time, the high level of resource utilization had the

potential to sustain those pressures. The Committee's predominant policy concern remained

the risk that inflation would fail to moderate as expected. Future policy adjustments would

depend on the evolution of the outlook for both inflation and economic growth, as implied by

incoming information.

Market participants had largely anticipated the FOMC's decision at its May meeting to leave

the target federal funds rate unchanged, but some market participants were reportedly

surprised by the retention of the assessment that inflation was “somewhat elevated.” The

publication of the minutes of the May meeting elicited little market response. Over the

intermeeting period, however, investors seemed to reappraise their beliefs that the economic

expansion would slow and that monetary policy easing would be forthcoming. This

reappraisal seemed to be based in part on the release of some economic data in the United

States and abroad that were more favorable than expected. As a result, the expected path of

the federal funds rate over the coming year was marked up sharply in financial markets.

Yields on nominal Treasury securities at all maturities also rose over the intermeeting period,

with the most pronounced gains in forward rates three to five years ahead. Measures of

long-horizon inflation compensation based on inflation-indexed Treasury securities edged

slightly higher. Yields on investment-grade corporate bonds rose in line with those on

comparable-maturity Treasury securities, leaving their spreads little changed. In contrast,

spreads on speculative-grade corporate bonds narrowed. Equity prices were volatile at times

during the intermeeting period, but broad stock price indexes advanced modestly, on net, as

favorable news on the economy and announcements of mergers and acquisitions outweighed

the drag of higher bond yields. The foreign exchange value of the dollar against other major

currencies was little changed, on balance.

Gross bond issuance by nonfinancial businesses surged in May from the already robust pace

of earlier in the year. Acquisition-related financing continued to support corporate bond

issuance, but a significant share of recent issues was reportedly designated for capital

expenditures. Commercial paper outstanding was unchanged in May, but bank lending

maintained a strong pace. In the household sector, mortgage debt expanded at a slower pace

in the first quarter, reflecting the slowdown in home-price appreciation over the past year and

the lower pace of home sales. Interest rates available to prime borrowers on both fixed-rate

and variable-rate mortgages increased along with other market interest rates. Consumer

credit continued to expand at a moderate pace in the first quarter. After rising at a

particularly rapid rate in the first quarter, M2 increased at a more moderate pace in April and

May.

In preparation for this meeting, the staff reduced its estimate of the increase in real GDP in

the first quarter and marked up its forecast of the rebound in economic activity in the second

quarter, in large part because of a more substantial swing in inventory investment than

previously expected. The revisions, however, left the projection of economic growth over

the first half of the year unchanged. As was the case in May, economic activity was expected

to increase at a rate a little below that of the economy's long-run potential for the remainder

of the year and to rise at a pace broadly in line with potential output growth in 2008. The

projected gradual acceleration in economic activity in coming quarters largely reflected the

expected waning of the drag from residential investment and improvements in the pace of

business fixed investment. Increases in energy and food prices over the intermeeting period

led the staff to revise up its forecast for headline PCE inflation during the second quarter, but

its projection of core PCE inflation was revised down. Although some of the recent slowing

in readings on core PCE inflation was likely due to transitory factors, the staff took some

signal from the data and trimmed its forecast for core PCE inflation slightly in coming

quarters. Over the next several quarters, total PCE inflation was projected to moderate to a

pace close to core PCE inflation.

In their discussion of the economic situation and outlook, participants noted that economic

activity appeared to have expanded at a moderate pace on balance over the first half of the

year. In view of incoming data and anecdotal information, participants continued to

anticipate moderate economic growth in coming quarters, with growth rising gradually to a

pace close to that of potential output. Participants interpreted the most recent information on

business spending, business sentiment, and the labor market as suggesting that the risks to

growth were more balanced than at the time of the May meeting, despite the ongoing

adjustment in the housing sector and the significant recent increases in longer-term interest

rates. Participants generally expected that inflation would probably edge lower over the next

two years, reflecting the waning of temporary factors that had boosted prices last year and a

slight easing of pressures on resources. Recent data on core consumer prices were

encouraging in this regard, but participants were wary of drawing any firm conclusions about

future trends from a few monthly readings that could reflect transitory influences and

remained concerned about forces that could contribute to inflation pressures. Against this

backdrop, participants agreed that the risk that inflation would fail to moderate as expected

remained their predominant concern.

In preparation for the Federal Reserve’s semiannual report to the Congress on the economy

and monetary policy, the members of the Board of Governors and the presidents of the

Federal Reserve Banks submitted individual projections of the growth of nominal and real

GDP, the rate of unemployment, and core consumer price inflation for the years 2007 and

2008, conditioned on their views of the appropriate path for monetary policy. The

projections for the growth of nominal GDP were in the range of 4-1/2 to 5-1/2 percent, with a

central tendency of 4-1/2 to 5 percent for 2007; for 2008, the projections for nominal GDP

growth ranged between 4-1/2 to 5-1/2 with a central tendency of 4-3/4 to 5 percent.

Projections for the rate of expansion in real GDP in 2007 were in a range from 2 to 2-3/4

percent in 2007, with a central tendency of 2-1/4 to 2-1/2 percent; for 2008, the projections

ranged between 2-1/2 to 3 percent, with a central tendency of 2-1/2 to 2-3/4 percent. These

rates of growth were associated with civilian unemployment rates in the range of 4-1/2 to

4-3/4 percent in the fourth quarter of 2007 and 4-1/2 to 5 percent in the fourth quarter of

2008; the central tendency of these projections was 4-1/2 to 4-3/4 percent in 2007 and about

4-3/4 percent in 2008. Projections for the rate of inflation, as measured by the core PCE

price index, in 2007 were in a range of 2 to 2-1/4 percent in 2007 and 1-3/4 to 2 percent in

2008. The central tendencies of these projections in 2007 and 2008 were identical to the

ranges for those years.

Participants generally agreed that the housing sector was likely to remain a drag on growth

for some time yet and represented the most significant downside risk to the economic

outlook. Although starts of single-family homes had moved up, on balance, over recent

months, permits for new construction continued to decline. A number of participants noted

that inventories of new homes for sale remained quite elevated. Housing activity was seen as

likely to continue to contract for several more quarters. Participants also identified a number

of downside risks associated with their outlook for residential construction. The recent

increase in interest rates for prime mortgages could further dampen the demand for housing.

Moreover, a number of participants pointed to rising mortgage delinquency rates and related

difficulties in the subprime mortgage market as factors that could crimp the availability of

mortgage credit and the demand for housing.

Spillovers from the strains in the housing market to consumption spending had apparently

been quite limited to date. To be sure, personal consumption expenditures appeared to be

rising more slowly in recent months than earlier in the year, but that development was

probably, at least in part, a result of the rise in gasoline prices, which was not expected to be

extended. Participants generally anticipated moderate gains in consumption spending over

coming months, supported by the strong labor market and solid growth in personal income.

Still, the advance in spending was expected to fall short of income growth, and the saving

rate was anticipated to trend higher over coming quarters from the unusually low levels of

recent years. Some participants noted a risk that the saving rate could rise more than

currently foreseen, particularly if household wealth were depressed by a further softening in

house prices or by a less buoyant equity market that might accompany a potential slowing in

the growth of corporate earnings. Several participants noted that higher interest rates and a

potential tightening in credit availability might also be factors that could contribute to a rise

in the personal saving rate. At the same time, participants recognized that consumption

growth had held up to date and saw a risk that the saving rate could fail to rise as much as

currently expected, particularly if equity markets continued to register significant gains.

A number of participants remarked that the recent data on business spending were more

encouraging than those available at the time of the May meeting. In particular, orders and

shipments for nondefense capital goods had stepped up, on balance, from March through

May, and survey indicators of business conditions had improved of late. Strength in foreign

demand for U.S. goods and services was another factor that seemed likely to contribute to the

firming of business spending. Participants noted that inventories appeared to be better

aligned with sales, boding well for a resumption of inventory accumulation and a pickup in

manufacturing activity. At the same time, some recognized the possibility that downside

risks to investment spending persisted. Longer-term interest rates and the cost of credit

generally had moved higher of late, the growth of business profits seemed to be moderating,

and measured productivity growth had been slower. Although credit market conditions

seemed to remain generally quite accommodative, in the days just prior to the meeting, the

availability of credit to some highly leveraged and other lower-rated borrowers appeared to

be tightening a bit and investors seemed to reevaluate the risks associated with investments in

complex and illiquid financial instruments.

Strength in spending abroad and the decline in the exchange value of the dollar were seen as

factors boosting U.S. exports. The rise in global interest rates was cited as evidence of

increasing global demand, and some participants pointed to strength of aggregate demand

worldwide and its potential effect on the prices of imports and globally traded commodities

as contributing to upside risks to U.S. inflation.

Most participants judged labor market conditions to remain rather tight, particularly for the

most skilled workers. The continued tautness of labor markets was something of a puzzle in

light of below-trend economic growth over recent quarters, and this development seemed to

be connected with slower productivity growth lately. In their discussion of this issue,

participants noted that employment data for 2006 could ultimately be revised down, resulting

in a corresponding upward revision to productivity. Some participants also pointed to

evidence of lags in employment adjustments, particularly in the construction industry, as a

factor depressing productivity in recent quarters. These observations suggested that the

recent decline in productivity growth might prove smaller than now estimated and largely

transitory. Still, some decline in the pace of trend productivity growth could not be ruled

out--a development that could have implications for business costs and price pressures.

Some participants further noted that the level of the unemployment rate consistent with stable

inflation could be lower than previously thought--a possibility that would help to explain the

absence of outsized wage pressures in the current environment.

The incoming data on core consumer prices were viewed as favorable, but were not seen as

convincing evidence that the recent moderation of core inflation would be sustained.

Participants noted that monthly data on consumer prices are noisy, and recent readings on

core inflation seemed to have been depressed by transitory factors. Moreover, a number of

forces could sustain inflation pressures, including the generally high level of resource

utilization, elevated energy and commodity prices, the decline in the exchange value of the

dollar over recent quarters, and slower productivity growth. In addition, while core

consumer price inflation had moderated of late, total consumer price inflation had moved

substantially higher, boosted by rising energy and food prices. While total inflation was

expected to slow toward the pace of core inflation over time, a number of participants noted

that recent elevated readings posed some risk of a deterioration in inflation expectations. On

this point, several participants cited the uptick in forward measures of inflation compensation

over the intermeeting period derived from Treasury inflation-indexed securities. However, a

portion of this increase might be attributed to technical factors, and survey measures of

long-term inflation expectations had held steady over recent weeks. Nonetheless, several

participants emphasized that holding long-run inflation expectations at or below current

levels would likely be necessary for core inflation to moderate as expected over coming

quarters.

In their discussion of monetary policy for the intermeeting period, members generally

regarded the risks to economic growth as more balanced than at the time of the May

meeting. Although the housing market remained a key source of uncertainty about the

outlook, members thought it most likely that the overall economy would expand at a

moderate pace over coming quarters. Members generally anticipated that core inflation

would remain relatively subdued but concurred that a sustained moderation in inflation had

not yet been convincingly demonstrated. In these circumstances, members agreed that

maintaining the target federal funds rate at 5-1/4 percent for this meeting was appropriate and

that future policy adjustments would depend on the outlook for economic growth and

inflation, as implied by incoming information.

In light of the recent economic data and anecdotal information, the Committee agreed that

the statement to be released after the meeting should indicate that the economy seemed to be

expanding at a moderate pace over the first half of the year. Members agreed that while

measures of core inflation had improved lately, the statement should indicate that a sustained

moderation of inflation remained in question and that high levels of resource utilization had

the potential to fuel inflation pressures. Against this backdrop, members judged that the risk

that inflation would fail to moderate as expected remained their predominant concern.

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 maintaining the federal funds rate

at an average of around 5-1/4 percent.”

The vote encompassed approval of the text below for inclusion in the statement to be

released at 2:15 p.m.:

“In these circumstances, the Committee’s predominant policy concern remains

the risk that inflation will fail to moderate as expected. Future policy

adjustments will depend on the evolution of the outlook for both inflation and

economic growth, as implied by incoming information.”

Votes for this action: Messrs. Bernanke, Geithner, Hoenig, Kohn, and Kroszner, Ms.

Minehan, Messrs. Mishkin, Moskow, Poole, and Warsh.

Votes against this action: None.

The Committee then again took up the topic of monetary policy communications. The

discussion at this meeting focused on several key elements of the Committee’s

communications vehicles: the statement released after each FOMC meeting; the minutes of

FOMC meetings; and the projections of FOMC participants that are summarized in the

Federal Reserve’s semiannual monetary policy reports to the Congress. The Committee

made no decisions at this meeting, and it was understood that the subcommittee on

communications issues would review the Committee’s discussions to date on these matters.

It was agreed that the next meeting of the Committee would be held on Tuesday, August 7,

2007.

The meeting adjourned at 2:20 p.m.

Notation Vote

By notation vote completed on May 29, 2007, the Committee unanimously approved the

minutes of the FOMC meeting held on May 9, 2007.

Vincent R. Reinhart

Secretary

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