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Fed officials face weak inflation, but split over what it means

WASHINGTON/SAN FRANCISCO: US Federal Reserve officials were ..

WASHINGTON/SAN FRANCISCO: US Federal Reserve officials were divided Friday over how seriously to treat a slide in inflation, with one top policymaker saying the Fed was “close” to its inflation target and three others warning the weak price increases posed major risks the Fed may need to attack with lower interest rates.

Just how deep that division is and where in the debate the most influential policymakers have staked their ground is going to grip the financial world between now and the conclusion of the Feds next meeting on July 31. Interest rate futures markets currently see a 100 per cent probability of a rate cut then, with the only debate in trading circles over whether the cut will 25 basis points or twice that.

Policymakers rate projections issued on Wednesday showed a near clean break at the Fed. Roughly half of officials see no rate reduction as likely appropriate this year, and roughly half see a cut of up to half a percentage point as probably warranted — a split that may turn on how quickly officials feel they should act.

The division took shape Friday, in the first hours after the lifting of the central banks formal “blackout” for commenting on the results of the last two-day policy session, which concluded Wednesday with the Fed leaving rates on hold in a range between 2.25 and 2.5 per cent.

“The economys baseline outlook is good — sustained growth, a strong labor market and inflation near our objective,” Fed vice chairman Richard Clarida said on Friday in an interview with Bloomberg Television.

Clarida said there was “broad agreement” that the case for rate cuts had grown stronger in recent weeks. He also said the Fed was ready to act “as appropriate,” a phrase emphasized by Chairman Jerome Powell earlier this month as markets slid over broad global growth and trade concerns.

But Claridas description of the current 1.5 per cent inflation rate expected this year as “close” to the Feds 2 per cent target suggested less compulsion to move soon.

Powell, asked after this weeks policy meeting about the danger of delaying any policy move, said “I dont think the risk of waiting too long is prominent right now.”

Others seemed to disagree.

“Recent indicators of inflation and inflation expectations have been disappointing,” Fed Governor Lael Brainard said on Friday in prepared remarks to a Fed conference in Ohio. With rates so low by historic standards, “basic principles of risk management…would argue for softening the expected path of policy when risks shift to the downside.”

Other problems have cropped up for the Fed, most notably the unpredictable path of US trade negotiations, and signs that global economic growth may be slowing. US economic data has also been choppy, with a weak recent jobs report and signs the manufacturing sector is slowing.

But the shortfall of inflation from the Feds 2 per cent target has become a persistent problem for the Fed, putting its credibility and the performance of the economy at stake.

While the Feds mandates from Congress refers to maintaining “stable prices,” central bankers globally feel that a bit of inflation is healthy. It allows wages and prices to rise steadily, encouraging businesses and households to spend and invest. For the central bank it provides room for them to keep interest rates above zero and, therefore, be able to react to a downturn with interest rates cuts alone.

The threat of inflation drifting downward is twofold.

Waiting too long means more aggressive Fed action could be required. In an era when the benchmark policy rate is already so low, that could mean again hitting the zero lower bound and forcing the politically difficult decision to ramp up “unconventional” policy tools like bond-buying once again.

Brainard also sketched out the threat of a self-reinforcing spiral that could take hold if the Fed does not lift inflation higher, with weakened expectations dragging down actual inflation, and leaving the centrRead More – Source

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