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ANALYSTS: SOFT US CPI CORE PROBABLY WON'T LET FED SNUG IN OCT
By Steven K. Beckner
Market News International - The modest rise in core consumer prices last month further convinced most, but not all, analysts that the Federal Reserve will stay on hold at its October 5 Federal Open Market Committee meeting, despite what they see as a growing risk of potential inflation.
If the Fed does not move to tighten in October, though, it is probably just a matter of time until it does -- quite possibly before the end of the year, some analysts said.
The Labor Department reported that the consumer price index rose 0.3% as expected in August, as energy prices jumped 2.7%. But excluding food and energy, the core CPI rose just 0.1%, a tenth less than expected. Holding down the core were drops in airfares, tobacco and apparel prices, the latter two of which are expected to reverse in next month's report. Some analysts also pointed a dubious finger at the weak housing component, questioning whether it is accurately measuring housing costs.
Bureau of Labor Statistics analyst Patrick Jackman told Market News International the core has continued to decelerate from last year's 2.4% to an annualized 1.6% in the first eight months of this year. But Joseph Carson, chief fixed income economist for Deutsche Bank, remarked, "If they ever treated housing correctly, it wouldn't be decelerating, it would be accelerating."
"Experienced inflation is a lot more than reported inflation because of the way we measure housing," Carson said, adding that the drop in apparel prices was also misleading. Adjusting for allegedly mismeasured rents (and imputed rents) and for BLS methodological changes estimated to have reduced the CPI upward bias by at least 0.7%, Carson said "we have more inflation now than at any time in 1994," when the Fed was raising interest rates.
Carson said the Fed should be doing so again without delay if it wants to avoid an intensification of inflation pressures. "There's no question we still live in a tame inflation environment, but we've moved up," he said, adding that the higher energy costs which have driven the overall CPI up "will enter into wage negotiations." He predicted wage demands, which have been on the rise according to a variety of reports, "will continue to accelerate."
Given the "very strong demand" evidenced in the August retail sales report and the nascent wage-price pressures he sees, Carson said the Fed "has enough evidence to go again in October." If the Fed does not raise the federal funds rate another 25 basis points at that time, "it will just allow this (inflation) process to continue," he said. He said it would risk building inflation expectations in financial markets and raising speculation that it will eventually have to raise rates more than 25 basis points.
Christopher Rupkey, economist at Bank of Tokyo-Mitsubishi, stopped short of predicting an Oct. 5 rate hike, but said "I don't feel comfortable in saying they can't move or they will not move." Given the strength of demand and the Fed's announced intention to be "preemptive" when it can, an October move cannot be ruled out, he said, noting that the Fed's June 30 rate hike came on the heels of a 0.1% core CPI rise.
Strong retail sales and record sales of housing and autos are telling the Fed "interest rates should be higher," Rupkey said.
But others, while agreeing that the Fed is highly likely to have to raise rates again, strongly doubted the FOMC will find justification for doing so early next month.
"Obviously inflation remains pretty benign, and that diminishes the chances the Fed will take any policy action at the October meeting," said Richard Berner, chief economist for Morgan-Stanley. But he said he does expect the FOMC to return to a tightening bias because strong demand and other forces "point to higher inflation."
"Having moved twice ...(the FOMC) will probably decide to wait," Berner said, adding that the odds of an October rate hike are now "distinctly less than 50-50."
However, Berner said the likely lack of action at the next meeting need not mean inactivity until next year. Because the Fed has taken a variety of precautions to guard against year-end computer disruptions in financial markets, "Y2K will not stand in their way" at the November 16 FOMC meeting.
Berner said there is "a legitimate case" for accelerating inflation based on a combination of tight labor markets, revived worldwide demand, higher commodity prices and dollar weakness.
Paul Kasriel, chief economist for Northern Trust Co., was of the mind that further tightening is needed but that it will not come at the next FOMC meeting because the Fed "doesn't have the core smoking gun" on inflation that it needs.
Were the Fed to tighten in the absence of a clear inflation danger signal and precipitate a market sell-off, Kasriel said "The hearings on the Fed would make the Waco hearings look like a picnic. The Fed needs a Gulf of Tonkin incident."
Notwithstanding the soft core, which he considered suspect because of housing, apparel and tobacco, Kasriel said the overall CPI rise has major economic significance because of its impact on wage demands. "I don't think that workers bargaining for wages do so in terms of some core," he said.
Fed Governor Laurence Meyer, among others, has warned that productivity growth will restrain inflation only as long as wage growth lags behind productivity growth and has indicated he expects labor compensation to catch up to, if not exceed, productivity growth at some point.
Kasriel doubted Meyer-type thinking will prevail at the October meeting, but said the FOMC will almost certainly adopt a tightening bias. |
