US economy

Weak US inflation scrambles debate on Fed’s next move


Sluggish inflation numbers are persistently overshadowing firmer US growth and teeing up a debate in the Federal Reserve over whether the next move in interest rates may need to be down rather than up.

The US central bank, led by chairman Jay Powell, is likely to keep policy unchanged at 2.25 to 2.5 per cent when it meets on Tuesday and Wednesday. With US activity improving after a shaky start to the year and overseas risks diminishing, many analysts remain confident the Fed will keep rates at their current level for the remainder of the year.

But policymakers including Charles Evans of the Chicago Fed have opened the door to future discussions over whether the central bank may wish to lower rates if inflation disappoints further or growth takes an unexpected turn for the worse. Richard Clarida, the Fed’s vice-chair, this month noted in a CNBC interview that in 1995 and 1998 the central bank had taken out some “insurance cuts” even though a recession was not looming.

Bill English, a Yale University professor who used to be director of the Fed’s monetary affairs division, said he did not see a compelling case for a rate reduction at present. “My guess is they stick with this for a while and let the data speak,” he said.

However, he added that if the Fed concluded over the summer and autumn that inflation was running lower than it wanted and the economy was slowing, it may want to push through one or two “easing moves” to see if that improved the outlook. 

The US on Friday posted strong growth, with the economy expanding at a 3.2 per cent annualised pace, adding to signs that a growth scare earlier this year was overstated. The headline figure was well above the US economy’s trend pace, and it comes on top of healthy US jobs growth and improving prospects in overseas economies including China.

As such, some economists find it difficult to see why the Fed should ditch plans to keep rates on hold this year and watch the incoming economic data for signs that inflation is finally beginning to gain traction. At its most recent meeting, the Fed did nothing to tee up the possibility of a rate cut, with minutes from the meeting stressing “significant uncertainties” about the outlook and adding that policymakers’ rates expectations could move in either direction.

But the picture is being complicated by a number of factors. First, the US headline growth figures vastly overstated the economy’s underlying strength, according to Bob Schwartz, senior economist at Oxford Economics. A key measure of underlying private demand expanded just 1.3 per cent in Friday’s Bureau of Economic Analysis report, down from 2.6 per cent in the fourth quarter.

And weak inflation data contained in the report only added to concerns that US price growth is decelerating even as wage growth firms up and unemployment hovers at just 3.8 per cent. The core personal consumption expenditures price index rose at a 1.3 per cent annualised pace in the first quarter, Friday’s figures showed, weaker than the 1.4 per cent Wall Street expectation.

Inflation’s persistent weakness is troubling the Fed, given the central bank has failed since the great recession to keep price growth sustainably at its 2 per cent target. Bond investors, said Mr Schwartz, “see the glass as half empty. They view the persistence of low inflation in the report as a sign the economy may be weaker than thought.”

The Fed’s latest minutes suggested policymakers are heavily divided over the next move. A number of officials insisted on keeping further rate rises on the table for later this year. For some, cutting rates could reawaken concerns about the risk of stoking risky bubbles in markets. Yet other policymakers are anxious about doggedly weak expectations on inflation. 

In his speech on April 15, Mr Evans said an acceleration of inflation from 2.25 to 2.5 per cent would not be a big concern, given how muted inflationary pressures appeared. “If activity softens more than expected, or if inflation and inflation expectations run too low, then policy may have to be left on hold — or perhaps even loosened — to provide the appropriate accommodation to obtain our objectives,” he said.

The Chicago Fed president has flagged up 1.5 per cent core inflation as a particular worry, saying that rate of inflation would be justification for deciding policy is too restrictive.

Mr Clarida had said a few days earlier that he did not see a recession on the horizon but that, historically, the Fed had not needed to identify a looming slump before lowering rates. “If you look back at Fed history, there have been times when the Fed in the ’90s took out some insurance cuts. We saw that in ’95. We saw that in 1998. So rate cuts are not always associated with recession.”

The public demands by Donald Trump, US president, for rate cuts are making Fed deliberations even more nettlesome. The central bank does not want to appear to be badgered into easing policy by Mr Trump, given how zealously it guards its independence. Nor does the Fed want to panic markets by appearing overly dovish.

“Fed officials would likely worry about the risks that a rate cut could appear political or unnerve markets, which might mistake a cut in response to low inflation for serious concern about the growth outlook,” said Goldman Sachs analysts led by Jan Hatzius in a recent note.



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