Weak inflation erodes conviction at Fed on rate hikes

The seal for the Board of Governors of the Federal Reserve System is displayed in Washington, U.S., June 14, 2017.   REUTERS/Joshua Roberts
seal for the Board of Governors of the Federal Reserve System is
displayed in Washington


By Ann Saphir and Lindsay Dunsmuir

DALLAS/WASHINGTON (Reuters) – When the Federal Reserve raised
rates earlier this week, Fed Chair Janet Yellen expressed
confidence that recent weak inflation readings were transitory.
Fed officials on Friday signaled that doubts are simmering.

In an interview with Reuters on Friday, Minneapolis Federal
Reserve President Neel Kashkari said he was not alone at the U.S.
central bank in his view the Fed should have waited to raise
interest rates until it was sure the recent drop in price
pressures really is temporary.

“I wish other people were joining me in my dissents, I’ll say
that,” Kashkari said in a phone interview with Reuters. “I think
that there’s more sympathy for my views, but maybe people aren’t
ready to take action.”

Kashkari was the lone policymaker to vote against the Fed’s
decision on Wednesday to raise its benchmark lending rate by a
quarter percentage point.

He also voted against the Fed’s first rate hike this year, in
March, although he said that his June decision was a closer call
because the labor market had clearly strengthened. But while many
of his colleagues were uncomfortable with risking a surge in
inflation if the Fed failed to act, Kashkari was more worried
about the costs of excessively low inflation.

Dallas Federal Reserve President Robert Kaplan on Friday also
signaled the decision to raise rates earlier this week was a
tough one, although he in the end supported a rate hike and said
he feels comfortable with that decision.

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“In this job you make trade-off decisions; I think the fact that
inflation of late has been more muted, for me, made me weigh
those trade-offs much more carefully,” Kaplan told reporters
after a meeting of the Park Cities Rotary Club in Dallas. But he
said he would want to see more evidence that inflation will rise
toward the Fed’s 2-percent inflation goal before increasing rates

“The run of weaker core inflation readings has clearly rattled
some Fed officials,” Capital Economics wrote in a note to clients
earlier on Friday.

The U.S. unemployment rate fell to a 16-year low of 4.3 percent
in May, but the Fed’s preferred measure of underlying inflation
has been running below target for more than five years and in
April slowed a second month to 1.5 percent.

That has led to some beginning to question the validity of the
traditional narrative of a tight labor market eventually sparking
higher inflation.

“Recent global developments add doubt to whether the traditional
dynamics still work,” Barclays economist Christian Keller said on
Friday. He cited the examples of Japan and Germany, whose
unemployment levels have declined to levels not seen since the
early 1990s but where wage pressures also remain sluggish.

At its latest meeting, the Fed scaled back its inflation
forecasts for this year to 1.6 percent but according to
policymakers’ median forecasts, still sees inflation rising to 2
percent next year. It also maintained its forecast of one more
rate hike this year and three the next.

But policymakers’ inflation forecasts are more optimistic than
forecasts by Fed staff, who provide economic intel to the Fed
Board of Governors. The latest Fed staff forecast shows they
expect inflation to still be below 2 percent in 2019.

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Still, Kashkari, who ran the Treasury’s bank bailout program
during the 2007-2009 financial crisis, said the level of concern
he feels now is “no comparison” to the feeling he had back then.

“If we are making a mistake, we are making a small mistake now
that I think we can recover from,” Kashkari said in the
interview. “I am not sounding an alarm bell like, ‘Iceberg

(Reporting by Ann Saphir; Editing by Chizu Nomiyama)

Read the original article on Reuters. Copyright 2017. Follow Reuters on Twitter.