Inflation fizzle may once
again leave Fed rate path in doubt
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[June 13, 2017]
By Ann Saphir and Jason Lange
SAN
FRANCISCO/WASHINGTON (Reuters) - The Federal Reserve will probably
express its confidence inflation will climb towards its 2 percent target
when it meets this week and delivers a widely expected rate rise, but
such assurances are a poor indicator of the Fed's future policy.
The Fed, which last raised rates by 25 basis points at its March
meeting, has penciled in three increases this year based on the view
that inflation will eventually edge higher as a result of a tighter
labor market that has driven the unemployment rate to a 16-year low.
Yet since March the Fed's preferred measure of underlying inflation has
fallen to 1.5 percent year-on-year after touching 1.8 percent in
February, even as unemployment rate has dropped to 4.3 percent of the
workforce.
The central bank is likely to go ahead with another 25-basis-point rate
increase on Wednesday, the fourth hike of a rate increase cycle that
started in December 2015, citing the improvement in the economy and
temporary factors driving down prices.
Fed officials have already noted a 9-percent drop in the cost of
cellphone plans since February. Falling pharmaceuticals prices and
slower rent increases have also mitigated inflationary pressures.
But the concern is the Fed and other central banks have been here
before, consistently over-estimating inflation in the recovery from the
2008-2009 financial crisis and the pace at which interest rates would
rise back towards pre-crisis levels.
"They are betting on the labor market tightness. They are still feeling
that will eventually lead to higher wages, higher inflation,” said Omair
Sharif, an economist at Societe Generale.
But that has been the Fed's bet for the past six or seven years, he
said. "There's a real chance that if the inflation data doesn't
cooperate the Fed is going to have to rethink."
The Fed has missed its inflation forecasts made at the end of 2012, 2013
and 2014. Those misses could be mostly attributed to forecasting errors
over the price of oil and the value of the dollar, factors largely
outside the Fed's control.
But now the 1.9 percent forecast for the end of this year, which Fed
officials have maintained since December 2015 when they started raising
rates from zero, also looks at risk.
WEAKENING CONVICTION
Investors are already taking notice.
A Reuters poll last week showed economists expect the central bank to
follow its June move with another 25 basis point increase in the third
quarter to take the fed funds rate to 1.25-1.50 percent.
But one in five said their conviction for that third 2017 rate hike was
fading, and traders of short-term rate futures now see just one rate
hike in 2018, down from two forecast earlier this year.
[to top of second column] |
A police officer keeps
watch in front of the U.S. Federal Reserve in Washington, DC, U.S.
on October 12, 2016. REUTERS/Kevin Lamarque/File Photo
They
are scaling back their expectations against the backdrop of inflationary
pressures ebbing not just in the United States, but globally.
The European Central Bank last week cut its inflation forecasts and predicted
weak prices for years to come.
The ECB has done no better than the Fed with its predictions and had said it
expected to see inflation approaching 2 percent ever since it started making
point forecasts in December 2013.
Other major central banks are also cutting their inflation forecasts. The
Reserve Bank of India made substantial downward revisions last week and the Bank
of Japan is expected to recalibrate its forecasts in July.
In China producer price inflation eased for a third successive month in May, the
latest data available, suggesting a cool-down in the world's second-largest
economy.
One factor that has repeatedly confounded policymakers was the behavior of
incomes during the post-crisis recovery.
Even
as the U.S. unemployment rate has almost halved in the past five years, earnings
have barely ticked higher, with annual increases picking up to 2.5 percent from
2.1 percent. In 2007, the last time the unemployment rate was firmly below 5
percent, earnings were rising by 3.5 percent a year.
Fed Chair Janet Yellen has argued the Fed must act on its forecasts because
changes in interest rate policy can take more than a year to impact the whole
economy. She also notes that the central bank is moving slowly to remove
monetary accommodation.
Carl Tannenbaum, Northwestern Trust's chief economist, said the Fed is not alone
in its struggle to predict how prices will behave.
"If you would have told me that U.S. unemployment rate would be down to 4.3
percent and still have core inflation struggling to get above 1.5 percent, I
would have been very, very surprised," Tannenbaum said.
For a grahic on inflation slowdown, click http://fingfx.thomsonreuters.com/gfx/rngs/USA-FED-INFLATION/010041JS3CE/index.html
(Reporting by Ann Saphir in San Francisco and Jason Lange in Washington; Editing
by David Chance and Tomasz Janowski)
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