No-show inflation poses conundrum for US Fed
After tightening monetary policy last month for the second time this year, the US central bank is expected to pause for the next few months to monitor developments. The Federal Reserve will leave the benchmark interest rate untouched when it meets on Tuesday and Wednesday, partly because it has yet to begin to wind down its huge stock of bond holdings, and will not make another move on interest rates until that process is under way.
But the Fed also faces a growing conundrum as it waits for signs of long-absent inflation to finally appear.
In the normal course of events, as an economy recovers and hiring increases, that brings with it rising wages and inflation, which in turn prompts the central bank to hike lending rates to keep prices in check while still allowing economic growth to continue.
But despite nearly seven years of uninterrupted job creation and a very low unemployment rate of 4.4 per cent, inflationary pressures and wage gains show little sign of life. The central bank is running out of explanations. While the Fed is expected to implement one more rate increase late this year, there are divisions among policymakers on the timing.
Minutes from the June meeting of the Federal Open Market Committee, the Fed’s policy-setting panel, show several members were not “comfortable” with plans to increase rates again this year.
Fed Chair Janet Yellen told Congress this month that the central bank was not blind to the data showing inflation stubbornly below the central bank’s two per cent target.
“We’re watching it very closely and stand ready to adjust our policy if it appears that the inflation undershoot will be persistent,” she said, but it is too soon to say flat prices are due to more than transitory factors.
Yellen and other economists have pointed to a series of one-off explanations, including lower drug prices and costs for mobile phone plans, some of which will continue to make their impact felt on the annual inflation rate for some months.
But baffled economists are beginning to doubt whether that is the whole story.
“There’s a litany of excuses and reasons why wages have hit a speed bump in the US, why inflation has hit a speed bump in the US,” economist Diane Swonk said. But she said, “I’m getting to the point where I’m hard pressed to find an explanation. It’s starting to bother me.”
Inflation is not simply weak — it is deserting the battlefield altogether.
The “core” measure of the Personal Consumption Expenditures price index — the Fed’s favourite inflation indicator — has been below the central bank’s two per cent target for five years.
Last month, the headline PCE price index contracted for the second time in 2017.
The Consumer Price Index also came in flat in June after contracting in May, dragging the 12-month measure down more than a full percentage point in the last four months.