EUR/USD

U.S. GDP increased at a 3.5% annualized rate in the third quarter, the Commerce Department said on Wednesday in its second estimate of third-quarter GDP growth. That was unchanged from its estimate in October and well above the economy's growth potential.

The economy grew at a 4.2% pace in the second quarter. While businesses accumulated inventory at a faster pace and spent more on equipment than initially thought in the third quarter, that was offset by downward revisions to consumer spending and exports.

Solid third-quarter growth is expected to keep the Federal Reserve on course to raise interest rates in December for the fourth time this year, despite an escalation of criticism from Trump that tighter monetary policy is slowing down the economy. The second estimate for the July-September quarter GDP growth was in line with market expectations. U.S. financial markets were little moved by the data.

Growth estimates for the fourth-quarter are currently around a 2.5% pace. The market expects GDP growth to slow further in 2019 as the fiscal stimulus fades and the effects of a bitter trade war with China as well as a strong dollar take their toll.

The third-quarter growth slowdown mostly reflected the impact of Beijing's retaliatory tariffs on U.S. exports, including soybeans. Farmers front-loaded shipments to China before the tariffs took effect in early July, boosting second-quarter growth. Since then, soybean exports have declined every month, increasing the trade deficit.

Imports increased a little bit faster in the third quarter than previously estimated while the drop in exports was much sharper, leading to an even wider trade gap, which sliced off 1.91 percentage points from GDP growth in the third quarter, instead of the 1.78 percentage points reported last month. That was the most since the second quarter of 1985.

The rebound in imports was partially driven by strong domestic demand and also reflected a rush by businesses to stockpile before U.S. import duties, mostly on Chinese goods, came into effect late in the third quarter.

Imports subtract from GDP growth. But some of the imports likely ended up in warehouses, adding to the stockpile of inventory, which contributed to GDP. Inventories increased at an $86.6 billion rate, instead of the $76.3 billion rate estimated in October.

As a result, inventory investment added 2.27 percentage points to GDP growth. That was more than the 2.07 percentage points reported last month and was the biggest contribution since the fourth quarter of 2011.

Growth in consumer spending increased at a 3.6% rate in the third quarter, down from the 4.0 percent rate estimated in October.

Business spending on equipment increased at a 3.5% rate, instead of the previously reported 0.4% rate. That was still the slowest pace in two years.

The Federal Reserve should be even more attentive to new economic data as its gradual interest-rate hikes edge it ever closer to a neutral stance, Fed Vice Chair Richard Clarida said on Tuesday.

In a carefully worded speech that comes on the heels of another volatile market drop, Fed Vice Chair Richard Clarida stressed how difficult it is for the U.S. central bank to determine both the neutral interest rate and the maximum level of employment.

"This process of learning... as new data arrive supports the case for gradual policy normalization, as it will allow the Fed to accumulate more information from the data about the ultimate destination for the policy rate," he said.

The Fed has settled into a quarterly rate-hike cycle and is expected to tighten policy again next month. But signs of a slowdown overseas and nearly two months of market volatility - including a sharp selloff last week - have clouded an otherwise mostly rosy U.S. picture in which the economy is growing well above potential and unemployment is the lowest since the 1960s.

Clarida, who joined the Fed in September, said the central bank should aim to sustain U.S. growth and guard against a rise or fall in inflation away from a 2% target.

"At this stage of the interest rate cycle, I believe it will be especially important to monitor a wide range of data," he said at the Clearing House conference of bankers and market operators in New York. "Risks have become more symmetric and less skewed to the downside" than years past, he said.

In September, Fed policymakers estimated that the "neutral" policy rate - which, theoretically, would neither spur nor curb demand in the economy - was about 3%. They also expected to hike the rate from 2-2.25% currently to a bit above that level by around early 2020, according to the estimates.

But some investors now question whether the Fed will raise rates three or more times in 2019 as planned, or stop the tightening cycle some time in the first half of the year.

On Tuesday, Clarida offered few hints. He said there are "a range of views" among policymakers about where neutral is, and that it "is a matter of judgment." Clarida was focused on inflation expectations among other indicators, and said that while he expects prices to remain anchored at target, he was watching for signs that the Fed's preferred gauge could be "running at somewhat less than 2%."

But overall, the economy's fundamentals and labor market remain "robust" with wage growth picking up, he said, predicting growth will continue at least through the second half of next year marking the longest U.S. expansion on record.

The euro zone has lost some growth momentum but this was mostly normal and not enough to derail plans by the European Central Bank to dial back stimulus further, ECB President Mario Draghi said.

Euro zone growth has been disappointing since the summer months, and Germany, the bloc's biggest economy, even contracted last quarter, raising some concern that the ECB may be cutting support at the worst possible moment.

"A gradual slowdown is normal as expansions mature and growth converges towards its long-run potential," Draghi said.

"Some of the slowdown may also be temporary," Draghi added. "In fact, the latest data already show some normalising of production in the car industry which has been impeded by one-off factors."

Still, data on Monday showed that German business morale fell by more than expected in November, pointing to weak growth this quarter, even if a rebound was still likely.

But Draghi along with ECB chief economist Peter Praet and board member Sabine Lautenschlaeger all said the case to end the ECB's 2.6 trillion EUR bond purchase scheme remained unchanged as inflationary pressures build and employment is rises.

The ECB is due to decide on ending the bond buys on December 13 but the decision is seen largely a formality as bar to changing this guidance is very high and would require a true shock.

Praet said the fall in crude oil prices, 30% since early October, was a positive for the bloc as the euro zone is a net importer and cheaper crude increases disposable incomes.

Praet added that the ECB could in December provide more elaborate guidance on the time-frame for reinvesting cash from maturing bonds.

With fresh purchases ending in December, reinvestments will become the bank's key tool to influence market prices and setting the time horizon for buys is a way for the ECB to provide support.

The ECB currently guides markets for reinvestments for an "extended period" which markets interpret as two to three years.

"At the following meetings of the Governing Council, we have to explain a little bit what we mean by an extended period of time," Praet said.

"I cannot tell you about the December meeting but I think you’re right to expect the ECB to clarify what we mean that we expect to reinvest for an extended period of time," Praet said. "How are we going to clarify this, let’s wait for December."

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