Monday, 23 November 2009

Rise in inflation won't move Fed to change rate stance yet

Inflation in the United States and other major economies appear to be accelerating again. However, for the time being, central banks are unlikely to get too alarmed.

In a speech to the Economic Club of New York last week, Federal Reserve chairman Ben Bernanke reiterated the Fed's view that the federal funds rate is likely to stay at exceptionally low levels for an extended period. This is based on the low rates of resource utilisation, subdued inflation trends and stable inflation expectations in the US.

This is despite the fact that last week provided hints that disinflationary conditions prevailing since the start of the financial crisis last year may be coming to an end.

The US consumer price index rose in October by 0.3 percent after having risen by 0.2 percent in the previous month. Although the index has fallen 0.2 percent over the past 12 months, the decline essentially occurred at the end of 2008. Since the beginning of 2009, the index has been rising at an annualised rate of 3.0 percent. Over the past three months, the rate of increase accelerated to 3.6 percent.

Core inflation, as measured by the consumer price index excluding food and energy, also showed an increase in October. Core prices rose 0.2 percent in last month, the same rate as in September, and the 12-month rate went up to 1.7 percent in October from 1.5 percent in the previous month.

Meanwhile, one measure of resource utilisation, industry capacity utilisation, rose in October for the fourth consecutive month. Diminishing slack in resource utilisation is a potential source of inflationary pressure. The utilisation rate, at 70.7 percent, remains much lower than the 1972-2008 average of 80.9 percent though.

Other economies are also showing a return of inflation. In the euro area, the 12-month consumer price inflation rate rose to -0.1 percent in October, up from -0.3 percent in September after prices rose 0.2 percent in October alone. In the UK, the inflation rate rose to 1.5 percent in October from 1.1 percent in September. In Canada, the inflation rate read 0.1 percent October, a sharp turnaround from -0.9 percent in September.

The return of inflation in most of the major economies has mostly been the result of higher energy prices. Most economists expect that the less-than-robust recovery in most of these economies will keep further gains in inflation in check.

For example, the Organisation for Economic Co-operation and Development expects inflation to level off again next year.

In its report on the economic outlook released last week, it said that although growth has resumed in the OECD economy, "the continued need to strengthen financial institutions, on-going private sector balance sheet adjustment and waning macroeconomic policy support are likely to imply a moderate recovery". With recovery expected to be moderate, unemployment is projected to continue to rise until the end of next year.

The resulting slack in the economy is expected to push down underlying inflation. The inflation rate for the OECD economy is projected to rise from -0.1 percent in the third quarter of 2009 and 0.7 percent in the fourth quarter to 1.4 percent in the first and second quarters of 2010 before moderating again thereafter.

With regard to monetary policy, the OECD report said that "[l]ow inflation and large negative output gaps call for waiting until the recovery is well underway before starting to normalise policy interest rates in the United States, the euro area, the United Kingdom and Canada".

So if Bernanke sees no need to adjust monetary policy soon to fight inflation, he is not alone.

1 comment:

Anonymous said...

Thanks for giving a thoughtful view on the inflation issue. has a good piece today on how the debt will inevitably force the government to inflate the currency.

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