Inflation Next Year's Worry for Fed?
Sunday May 20, 4:15 pm Eastern Time
By Glenn Somerville
<<WASHINGTON (Reuters) - The U.S. Federal Reserve's resolve to battle an economic slowdown by slashing interest rates amid rising energy costs and slowing productivity may expose the economy to inflation risks ahead, analysts caution.
With the economy still chugging ahead slowly, inflation is unlikely to be this year's problem since demand is relatively muted. That, however, could change swiftly if the expansion regains some steam by next year.
Tuesday's decision by Fed policymakers to cut rates for a fifth time this year by a half percentage point drew warnings that the U.S. central bank might be lowering its traditional guard against price pressures in pursuit of growth.
``The (Federal Open Market) Committee has placed a far higher priority so far on managing the economic slowdown, and preventing a capital spending collapse, than on ensuring that its policy remains consistent with its longer-term goal of continued low, stable inflation,'' the Bank of America advised its clients after the policymaking FOMC's announcement.
The Fed has lowered its benchmark federal funds rate by 2-1/2 percentage points this year to 4 percent -- an exceptionally aggressive series of actions that puts billions of dollars worth of new spending power into the economy by lowering borrowing costs for consumers and corporations alike.
SHRINKING PROFITS A KEY WORRY
Throughout its rate-cutting campaign, the central bank has stressed its concern that corporate profits were under pressure and that spending on new capital equipment was waning.
Economist David Jones of Aubrey G. Lanston & Co. in New York said there was a risk corporations might feel justified about pushing their prices up to recover higher costs and labor charges that many have been absorbing in recent years.
``The highest priority for the Fed clearly has been to deal with the weakness that it sees in the corporate sector,'' Jones said. ``It's been possible to do that because there's still really no pricing power out there, but that could become next year's problem.''
Inflation measured by the Labor Department's Consumer Price Index rose a relatively modest 0.3 percent in April after a 0.1 percent rise in March, the department reported on Wednesday. But that left inflation running at a 3.3 percent rate over the past 12 months, higher than the 2 percent range that many at the Fed consider ideal, as energy costs have risen.
Energy prices last month climbed 1.8 percent, led by gasoline costs, up 5 percent. That gain was partly offset by a 1.6 percent drop in natural gas costs and a 2.1 percent decline in fuel oil prices.
PRODUCTIVITY RATES SQUEEZED
At the same time that inescapable charges for energy have been rising, unit labor costs have been climbing according to government statistics. That squeezes companies' ability to keep raising rates of productivity, or output per worker, that have enabled many to keep a lid on prices.
``I don't think there's an immediate issue here for the Fed because they're faced with an...economy that is giving off mixed signals of either recession or protracted weakness,'' said economist Tim O'Neill of Harris Bank/Bank of Montreal in Toronto.
``But once there is a clear sign of recovery, alleviating the cost squeeze for corporations by raising prices will become a real possibility,'' O'Neill said, adding that the Fed might be ''taking back some of the easing that it has offered and I suggest that could happen as early as in the fourth quarter.''
The Fed itself maintained on Tuesday that it felt prices were in check. ``With pressures on labor and product markets easing, inflation is expected to remain contained,'' the Fed said, evidently still pinning its hopes on rising productivity.
While productivity ``stalled in the first quarter, the impressive underlying rate of increase that developed in recent years appears to be largely intact, supporting longer-term prospects,'' the Fed said in a statement laying out its decision.>> |
