10 August 2020

Rising Inflation To Be In Focus

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Federal Reserve officials are likely to keep interest rates steady at their two-day policy meeting that concludes Wednesday, but they could debate the outlook for rate increases later in the year and what strengthening inflation means for monetary policy.

Fed Chairman Jerome Powell won’t hold a press conference after the meeting, and officials aren’t releasing new economic projections. Still, the internal discussions could be lively, though we could see few hints of the debate in the new policy statement, to be released at 2 p.m. EDT. Here’s a look at the main issues:

The Rate Path 

Officials in March penciled in two more rate rises this year but were about evenly divided between those who favored two and those seeing three additional increases.

Because markets expect the Fed to next raise rates at its June meeting, a big question looming over the May gathering is the policy path for the rest of the year.

The statement isn’t likely to signal whether more officials are leaning toward raising rates three additional times this year, instead of two. Watch instead for the release of the meeting minutes in three weeks and policy makers’ speeches and other commentary later this spring.

Inflation Rebounds 

Fed officials spent much of 2017 struggling to explain a surprising weakness in inflation that threatened to slow down their rate rises. That concern now appears to be in the rearview mirror. Instead, the discussion is turning to how high they might let it go before picking up the pace of rate increases.

Annual inflation has returned to the Fed’s 2% target, according to data released Monday. So-called core prices, which exclude the volatile food and energy sectors, rose 1.9% through March, up from 1.5% in December.

Also important to Fed officials: Investors’ expectations of future inflation have risen this year. The 10-year inflation break-even rate, which reflects the yield premium on the 10-year U.S. Treasury note over the comparable Treasury inflation-protected security, has settled recently at its highest levels in four years.

Watch the statement for any new language on inflation. Officials could change the line in their March statement that annual inflation “continued to run below 2 percent” and another saying that market-based measures of inflation compensation “remain low.”

Pay particular attention to any changes in their description of the inflation outlook—which matters more for the rate path. In March, they said annual inflation was “expected to move up in coming months and to stabilize” around 2%.

The Balance of Risks 

For the past year, the Fed’s policy statement has referred to the near-term economic risks as “roughly balanced,” meaning the prospects of growth that is either stronger than anticipated or weaker than anticipated are about the same.

The economy grew at a 2.3% annual rate in the first quarter, according to the Commerce Department’s initial estimate, down from 2.9% in the fourth quarter. The figures are unspectacular but still faster than what Fed officials expect over the long run.

The March meeting minutes showed officials are likely to look past any weakness in the first-quarter figures, which have typically been soft and followed by a second-quarter rebound.

Labor Markets 

The unemployment rate has held steady, at 4.1%, since October. Hiring has been strong, with employers adding 202,000 jobs a month on average this year. Officials have little reason to revise the language in their statement that for several meetings has described the labor market as strong.

Still, the question of how much lower the unemployment rate can fall before wages rise—and whether wage increases, in turn, will fuel stronger price pressures—figures to be among the most important officials must grapple with this year.

How Far From Neutral 

The Fed is probably a few more interest-rate moves away from a neutral interest-rate setting, or the level at which its short-term benchmark rate neither stimulates nor slows growth.

Two big questions for officials this year are how far do they need to raise rates to reach neutral, and how much beyond that level do they expect to raise rates to keep inflation under control.

The challenge for central bankers is to slow growth to a sustainable pace, but not to tighten policy so much that the economy tips into recession.

Fiscal Fitness 

Recently enacted tax cuts and a government spending increase are set to provide more stimulus to the economy amid already low unemployment and firmer inflation. Fed officials have to sort out how much these changes could boost growth and price pressures.

It’s probably too soon for them to have reached firm conclusions on this front. But the upturn in inflation, which occurred largely before the fiscal stimulus ripples through the economy, could add a new dimension to these discussions.

Late last year, officials began to raise their growth projections due to the tax-cut legislation, but they held back from revising their interest-rate projections because of low inflation readings. Higher inflation could make it harder to maintain that position.

Click here for the original article from The Wall Street Journal. 

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