Low inflation may slow Fed rate hikes
Washington – — The Federal Reserve ended 2014 with a pledge to be “patient” in raising interest rates from record lows. The way things are going, its patience may endure for a long while.
Though the U.S. economy has steadily improved, inflation has dipped further below the Fed’s target rate. Chalk it up to plunging oil prices and a surging dollar, which makes foreign goods cheaper in the United States.
Complicating the Fed’s timetable is the European Central Bank’s just-announced plan to pump 1 trillion-plus euros into its ailing economy. That flood of cash should keep the eurozone’s rates ultra-low. Many investors may respond by shifting into higher-yielding U.S. Treasurys. That would strengthen the dollar even more and could push U.S. inflation further below the Fed’s 2 percent target.
Under that scenario, the Fed might find it hard to justify a rate hike, which risks weakening the economy and slowing inflation further. As the Fed meets this week, some economists who had predicted a rate increase by June now think September might be more realistic.
“The Fed has every reason to continue to be patient,” said David Wyss, an economics professor at Brown University. “Standing pat is the best thing to do right now.”
In a statement it will issue when its meeting ends Wednesday, the Fed is expected to repeat phrasing it introduced in December: That it “can be patient” in starting to raise its key short-term rate, which the Fed has held near zero since December 2008.
Even before the ECB acted last week, anticipation of its move had helped cut the euro’s value to a decade-long low against the U.S. dollar. The dollar is also being driven up by strengthening U.S. economic growth.
The plunge in world oil prices, which have fallen 60 percent since June, has kept inflation historically low in recent months. But U.S. inflation has been unusually low since the Great Recession began eliminating more than 8 million jobs and slowing consumer spending, home buying and manufacturing output.
The U.S. economy is now growing at a consistently solid pace. Job growth has accelerated, with the economy having added nearly 3 million jobs last year — enough to cut the unemployment rate to 5.6 percent, the lowest level since 2008 and barely above the Fed’s goal of 5.2 percent to 5.5 percent.
But Fed officials, including Chair Janet Yellen, have pointed to other factors — such as weak pay growth and a still-high number of part-time workers who can’t find full-time jobs — as evidence that more must be done to achieve a healthy job market.
The factor that may be giving the Fed the most pause about a rate hike is excessively low inflation. Prices rose just 1.2 percent in the 12 months that ended in November, according to the Fed’s preferred gauge of inflation. When inflation is too low, consumer spending can slow as people delay purchases on the assumption that the same or lower prices will be available later. The biggest fear is deflation — a broad decline in prices and income that can further restrain spending and even tip an economy into recession.
Yellen, who succeeded Ben Bernanke a year ago, has shown she is in command of Fed policy, backed by a majority of officials. Scattered dissenting votes against the Fed’s policy statements have come primarily from a minority faction of “hawks.” These are officials who think the Fed is raising the risk of future high inflation or asset bubbles by keeping rates so low for so long.
But two of the most vocal hawks, Charles Plosser, head of the Fed’s regional bank in Philadelphia, and Richard Fisher, his counterpart in Dallas, no longer have votes this year under the rotation system for Fed bank presidents. Both are retiring from the Fed in March.
The new set of voters lean mainly to the “dovish” camp of officials who think the biggest worry right now is a still less-than-fully-healthy economy and too-low inflation.
Copyright 2015 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.