By Steven K. Beckner
(MNI) – The predominant view at the Federal Reserve remains that
the underlying rate of inflation is not on the verge of a dangerous
acceleration, but mounting public concern about inflation has definitely
registered at the Fed.
For now and for the foreseeable future concerns about high
unemployment, a depressed housing market, relatively sluggish economic
growth and downside risks to the expansion are likely to keep monetary
policy in a very accommodative stance.
However, sources warn it could become more tricky to conduct
monetary policy if, while the economy remains soft, price pressures
prove to be more persistent than most Fed officials hope and/or if
rising inflation expectations threaten to reinforce those price
pressures.
And so, while the Fed can be expected to continue to downplay
inflation risks, it can also be expected to redouble its efforts to
reassure the public and financial markets of its committment to
preserving price stability with an eye toward keeping inflation
expectations under control.
For some Fed officials, inflation is already a real and mounting
threat. Most notably, Dallas Federal Reserve Bank President Richard
Fisher and Philadelphia Fed President Charles Plosser, both voting
members of the Fed’s policymaking Federal Open Market Committee, have
warned about growing price pressures. So have Kansas City Fed President
Thomas Hoenig and Richmond Fed President Jeffrey Lacker.
Earlier this month Fisher said the Dallas Fed’s “trimmed mean”
inflation index already is showing “a slight lifting of price
pressures” with “the least number of declining prices in several years.”
With oil and other input costs surging, he said the Fed must “watch very
carefully how much pricing power” firms have and “how much pass through”
of higher input costs there is.
Plosser warned “we are beginning to see some increasing price
pressures” and noted manufacturers surveyed by the Philadelphia Fed
“continue to report increases in their input costs, and they are more
inclined to raise prices than they have been in some time.”
Such fears seem to have been at least partially validated by
the data.
The Producer Price Index rose 1.6% in February, more than twice as
much as expected. Not only did energy jump 3.3%, food prices leaped
3.9%. Excluding food and energy, the core PPI for finished goods was up
0.2% — 1.8% compared to a year earlier.
The February Consumer Price Index also rose more than expected,
both in overall and core terms. It was up 0.5% overall and, for the
second straight month, 0.2% on a core basis. The core CPI is still up
just 1.1% year-over-year, but in December the year-over-year pace was
just 0.8%.
The Philadelphia Fed’s March “prices received” index rose to 22.6
from 21.0 in February, 17.1 in January and 10.7 in December. Before that
the index was negative. The Richmond Fed had similar findings in its
March survey of manufacturing, service and retail sectors. Its retail
price index was up to 1.81 in March, from 1.46 in February and 1.235 in
January.
Inflation expectations are also up, albeit “from very low levels,”
as Fed Chairman Ben Bernanke has said.
The University of Michigan’s consumer sentiment survey shows
Americans now expecting inflation to average 4.6% over the next 12
months compared to 2.7% last August.
The break-even “inflation compensation” spread between regular
Treasury and inflation protected securities has widened from 161 basis
points when Fed Chairman Ben Bernanke began heralding the resumption of
quantitative easing last Aug. 27 to as much as 255 basis points
recently. The spread now stands at 240. The five-year spread has widened
from 127 basis points on Aug. 27 to 264 basis points.
The rebound in the price of oil to more than $106 for U.S. light
sweet crude keeps alive fears of a possible spillover into broader
prices.
However, other officials are much more sanguine about inflation
than Fisher, Plosser et al. Most tend to echo Bernanke’s observation in
March 1 congressional testimony that “the most likely outcome is that
the recent rise in commodity prices will lead to, at most, a temporary
and relatively modest increase in U.S. consumer price inflation.”
Some Fed sources even say it is premature to conclude for sure that
disinflation has ended and that core inflation is now trending up.
A typical view is that the overall inflation numbers are being
affected by an oil “supply shock” that should prove transitory —
provided that inflation expectations remain anchored.
That is a key condition which officials of all stripes stress must
be maintained.
So long as expectations are anchored, Fed sources say there should
be very limited pass-through of oil and other commodity price increases
to core finished goods prices. They point out that ample slack in labor
markets is minimizing pressure on wages, which constitute the great bulk
of production costs. And they point to productivity gains that should
also exercise a restraining effect.
Nevertheless, even those who downplay inflation risks are quicker
these days to emphasize the need for the Fed to “monitor” inflation and
inflation expectations.
And indeed the “party line,” as enunciated by the FOMC, has
undergone a notable change. The Jan. 26 assertion that “measures of
underlying inflation have been trending downward” became more nuanced in
the March 15 statement.
Then, the FOMC said instead that “measures of underlying inflation
have been subdued.”
The March 15 statement went on to reiterate that “measures of
underlying inflation continue to be somewhat low, relative to levels
that the Committee judges to be consistent, over the longer run, with
its dual mandate.” But it added, “The recent increases in the prices of
energy and other commodities are currently putting upward pressure on
inflation.”
And it pledged, “The Committee expects these effects to be
transitory, but it will pay close attention to the evolution of
inflation and inflation expectations.”
More of these kinds of cautionary statements on inflation are
likely, even as some key economic indicators continue to cast doubt on
the strength of the recovery. Most recently, February durable goods
orders were reported down a surprising 0.9%.
Sources say the Fed is also likely to communicate more about how it
will ultimately implement an exit strategy from monetary accommodation
— again, with an eye toward providing assurances that the Fed has the
ability and the will to tighten credit in time to cap inflation and
thereby curb inflation expectations.
And so most officials continue to feel a fair amount of confidence
in the Fed’s ability to contain inflation within the FOMC’s implicit
target range of 1.6% to 2.0%. But they evince an increasing need to
express their determination to do so.
If they lose a grip on inflation expectations and headline price
pressures spill over into core inflation, sources say, the Fed’s job
will become considerably more complicated.
** Market News International **
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