Fed Reconsiders `Measured' Pace as Inflation Pressures Mount
March 21 (Bloomberg) -- Tomorrow's meeting of the Federal Reserve's policy-setting Open Market Committee may be one of the last at which U.S. central bankers will say they're satisfied with how the fight to contain inflation is going.
Figures since the FOMC's last meeting show a surge in the prices of oil, commodities and imports, as well as accelerating job growth. Those trends are heightening economists' concerns about inflation and raising speculation the Fed may soon abandon what it calls its ``measured'' pace in raising interest rates and boost rates more quickly.
``That's a very close call,'' former Fed Governor Laurence H. Meyer said about prospects the FOMC might scrap the language in its post-meeting statement. ``Everybody appreciates that it's going to need to be removed at sometime soon. I would think it's not far'' off -- possibly at the May or June meeting, he said.
The 22 firms that trade government debt directly with the Fed increasingly share that view. Economists from 13 of the primary dealers say the FOMC will remove ``measured'' by June, including three who say the description may become history tomorrow, based on a Bloomberg News survey conducted March 17 and 18. The Fed will raise its benchmark interest rate by a quarter-point tomorrow to 2.75 percent, the seventh increase in a row, according to 93 of 101 economists in a separate poll.
Fed Chairman Alan Greenspan, in four appearances before Congress since mid-February, didn't use ``measured'' to describe the expected rate of increases. Comments by other Fed members suggest they favor leaving the description intact. Each FOMC statement has used it since May.
Greenspan
``There's clearly a diversity of view within the Fed of what ought to be done,'' former Fed Governor Lyle Gramley said in an interview.
When asked at a Feb. 16 Senate Banking Committee hearing about whether the Fed may soon scrap the wording, Greenspan said that even though inflation is contained, ``We're not going to have the same statement in perpetuity. At some point it's going to change.''
In a similar vein, Atlanta Fed Bank President Jack Guynn said at a Feb. 9 event that ``you can imagine not too far down the road where some things in the statement aren't going to be appropriate.''
Greenspan may want to regain flexibility by shedding the phrase, said Glenn Haberbush, economist at Mizuho Securities USA in Hoboken, New Jersey, and one of three firms that expect the Fed to drop the wording tomorrow. Two other primary dealers expect it to happen either tomorrow or in May.
`Untying Their Hands'
``By dropping the pledge, they are just untying their hands, and Greenspan hates to have his hands tied,'' Haberbush said. ``The Fed is not necessarily implying they will raise rates faster or more aggressively.''
Other Fed members have stood by the phrase in recent weeks. Fed Governor Ben Bernanke and regional Fed bank Presidents Anthony Santomero of Philadelphia and Michael Moskow of Chicago all described the likely pace of rate increases as ``measured'' in recent public appearances.
``It's a much closer call than it was two weeks ago,'' Conrad DeQuadros, senior economist at Bear Stearns & Co. in New York said in an interview.
Regardless of whether the Fed changes its statement, economists say mounting inflation pressures may threaten the Fed's effort to raise interest rates gradually so as not to crimp the economic expansion. The Fed traditionally has found it more difficult to slow inflation once price rises have become built into the economy than to spur more economic growth.
`A New Urgency'
Recent data give the Fed ``a new urgency'' for pushing its target rate back to a so-called neutral range, where monetary policy no longer is spurring economic growth, ``and for not stopping until you get there,'' former Governor Meyer said.
Since the last FOMC meeting on Feb. 2, the CRB index of materials prices surged to a 24-year high; oil topped $56 a barrel again; the dollar's value fell another 2.2 percent against a basket of currencies tracked by the Fed; and reports showed further gains in import prices and the biggest jump in wholesale prices excluding food and energy since 1998.
A March 4 report saying that U.S. companies created 262,000 jobs in February jolted investors, who took it as a sign that wages soon may begin to accelerate.
Inflation Creep
The Fed's current policy may no longer be enough to restrain consumer price increases, said Stephen Stanley, chief economist at RBS Greenwich Capital, who sees the benchmark overnight lending rate rising to 4.25 percent by the end of the year.
``The Fed is trying to be preemptive, but eventually we are going to see inflation creeping into the system,'' said Stanley, a former economist at the Fed's Richmond branch. Greenwich, Connecticut-based RBS was the first of Wall Street's biggest bond- trading firms to predict the 2.25 percent year-end rate for 2004, according to a Bloomberg survey.
Price pressures already are showing up in the rates investors seek as protection against higher inflation. A month ago, Greenspan said he considered it a ``conundrum'' as to why market rates remained low even amid the Fed's multiple rate boosts.
``Three factors suggest upside inflation risks -- dwindling economic slack, rising costs, slower productivity growth and a still-accommodative Fed,'' said Richard Berner, chief U.S. economist at Morgan Stanley in New York, who expects the rate to reach 4 percent by year-end. ``To keep inflation stable in my view would require significantly tighter monetary policy.''
Company Pricing Power
Many of the businesses queried for the Fed's latest beige book, a survey of economic conditions across the country, ``indicated greater ease in passing along price increases,'' the central bank said in its March 9 report.
``The big picture for inflation is still benign, but the rumblings get a little louder with each succeeding beige book,'' said Stanley, the RBS Greenwich economist.
Northwest Airlines Corp., American Airlines Inc. and Continental Airlines Inc. raised fares on most flights in the U.S. and Canada by as much as $20 for a round trip, the companies announced March 11. XM Satellite Radio Holdings Inc., the largest U.S. pay-radio service, raised its subscription prices by 30 percent. Honda Motor Co., Japan's largest carmaker, said it plans to lower vehicle incentives in the U.S., the equivalent of a price increase, by about 20 percent.
``We have to work our way through a very difficult cost environment that we don't see changing for the next 12 to 18 months,'' said Richard Wolford, chief executive officer of Del Monte Foods Co., the largest U.S. maker of canned fruits and vegetables, in an interview March 3.
`Teflon Economy'
By all rights, inflation ought to be roaring ahead in the U.S., says David Wyss, chief economist at Standard & Poor's, the New York-based credit rating company. Yet, consumer prices are 3 percent above their level of a year ago, and the latest Bloomberg monthly survey of economists predicts they'll average 3.5 percent higher in 2005.
``If you look at the mid-1970s and early 1980s, these are the kinds of conditions that we used to associate with double- digit inflation,'' said Wyss, who was a White House economist under President Jimmy Carter, when inflation topped 13 percent in 1979 before finally leveling off in the mid-1980s.
``Today, it's a Teflon economy,'' he said.
Rising U.S. productivity and increased competitive pressures have helped change the way the U.S. uses oil and other commodities, Wyss said. Since March 2000, productivity has grown at an average 3.5 percent pace, more than double the 1.5 percent pace averaged during the 1970s and 1980s. Wyss says rapidly rising productivity enables employers to meet rising demand for their products without hiring as many new workers as they would have had to in the 1970s and 1980s
``Productivity growth solves a lot of problems,'' he says.
More to Come
Not everyone expects the Fed to have to act soon. Richard Yamarone, chief economist at Argus Research Corp. in New York, says the surges in oil and commodity prices are likely to weaken the economy over the next quarter or two, much as they did after the oil-price increases of 2004.
``There's ample evidence we've already hit a soft patch,'' Yamarone said in an interview.
David Malpass, chief economist at Bear Stearns in New York, says that may be optimistic and that price increases may soon push the Fed closer to having to raise rates more sharply or longer than investors now expect. Malpass expects rate increases to grow to half a percentage-point soon, pushing the federal funds rate to 4.5 percent by year-end.
``The inflation rate will start kicking up even higher'' later this year, Malpass said in an interview. ``If that keeps up, the Fed will have to move to 50-basis-point hikes. I'm thinking that'll come sometime in the third quarter.''
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