Bernanke Comments Suggest Fed's Rate Policy Is On Hold for Now
The Federal Reserve's latest projections for core inflation signal the U.S. central bank has
yet to be convinced inflation is easing, suggesting monetary policy will stay on hold until it sees more compelling data.
In its semi-annual report to Congress Wednesday, the Fed left its forecasts for core inflation for this year and next unchanged, while slightly lowering its growth forecasts.
Since recent data has shown an easing in core, or nonfood, non-energy inflation, economists were surprised the Fed did not lower its core inflation forecasts from projections released
six months ago.
"Given that the current level of core inflation is already below the forecast they reported, this suggests that they truly are not convinced that the recent drop in inflation can be
sustained," said Drew Matus, U.S. senior financial markets economist at Lehman Brothers in New York.
The Fed's forecasts for the price index for personal consumption expenditures excluding food and energy -- the index they watch most closely -- were unchanged from February at 2 to
2.25 percent this year and 1.75 to 2 percent in 2008.
The most recent data showed the core PCE price index up 1.9 percent in May from year-earlier levels.
Economists also said the Fed's projections showed it would not be too worried if it saw an upward blip in core inflation in coming months.
"It appears some further increase in core inflation would not be a surprise to the Fed," said Dean Maki, economist at Barclays Capital in New York.
That may mean the Fed would not be tempted to consider raising benchmark overnight target interest rates even if monthly core inflation numbers worsened somewhat.
"The fact that the Fed did not lower its 2007 forecast for the core PCE ... means that the Fed is not going to become overly concerned if no further progress is made on core inflation this year," said Joseph LaVorgna, managing director and chief U.S. economist at Deutsche Bank in New York.
"Perhaps the hurdle for Fed tightening has been set a bit higher," he said. "Of course, this assumes that the economy performs as projected."
The Fed cut its economic growth projections by a quarter percentage point to a range of 2.25 percent to 2.5 percent this year and 2.5 percent to 2.75 percent in 2008, mainly due to a
steeper-than-expected downturn in housing construction.
Testifying on the twice-yearly report before the House Financial Services Committee, Fed Chairman Ben Bernanke made clear the central bank harbored concerns not only on core inflation, but on overall inflation as well.
"We're unhappy with inflation, including food and energy, running higher than we would like," he said.
"The real issue for us is if there are temporary bursts in prices of food and energy -- will those higher prices somehow get embedded in the long-run underlying trend of inflation."
Bernanke said one worry is the possibility that prices of consumer goods would rise to reflect the higher costs of materials, and another is that expectations of future inflation
might start to drift upward.
"Once that happens, it is much more difficult to keep inflation low," he said.
"So there are concerns there and part of the reason why we have to be quite vigilant on inflation at this juncture."
In a statement after its last meeting on interest rates in June, the Fed said that while core inflation had improved modestly, "a sustained moderation in inflation pressures has yet to be convincingly demonstrated."
That reinforced expectations that the Fed would stand pat through the year, despite a housing market downturn that has been weighing heavily on economic growth.
On Wednesday, however, financial markets took their cue from concerns Bernanke expressed about housing. He said that while the growth-dampening impact of that downturn should fade,
there was a risk the slump could prove more protracted than expected.
The Fed has left benchmark overnight borrowing costs steady at 5.25 percent since it ended a string of rate hikes in June of last year.