Federal Reserve policy makers are on guard for signs that investors and the public are losing confidence in their ability to keep prices stable in a moderate recovery with little wage growth.
“Many participants observed the committee should remain attentive to evidence of a possible downward shift in longer-term inflation expectations,” according to a record of the Oct. 28-29 Federal Open Market Committee meeting released today in Washington. “Some of them noted that if such an outcome occurred, it would be even more worrisome if growth faltered.”
Policy makers are watching the outlook for inflation as they weigh the timing of the first interest-rate increase since 2006, which most officials expect to happen next year. The Fed last month ended a bond-purchase program intended to boost growth, citing improvements in the labor market.
While unemployment has fallen faster than forecast, inflation has remained below the Fed’s 2 percent goal for 29 straight months, and the pace of price increases has been slowing.
Policy makers at last month’s meeting said the risk of inflation persisting below their goal had diminished. While some market-based measures of expectations had declined, surveys of consumers’ outlook for prices remained stable.
Since the FOMC meeting, one measure of inflation expectations has dropped. A Thomson Reuters/University of Michigan survey released last week showed that consumers see inflation averaging 2.6 percent a year five to 10 years from now, down from 2.8 percent predicted last month and the lowest reading since March 2009.
“Falling inflation expectations are likely to take center stage going forward,” said Thomas Costerg, an economist at Standard Chartered Plc in New York. “If the market doesn’t believe in their ability to push inflation up to 2 percent, that’s going to be a concern.”
The Standard & Poor’s 500 Index fell 0.2 percent to close at 2,048.72 in New York. The yield on the 10-year Treasury note increased four basis points, or 0.04 percentage point, to 2.36 percent on expectations the minutes don’t signal a change in the odds of a rate increase next year.
Low inflation damages an economy if it becomes sustained deflation, which can sap demand by encouraging consumers to delay spending in the expectation of lower prices in the future. Central bankers watch expectations as a signal for the direction of future inflation.
While officials last month were on guard for a possible decline, they considered expectations to be “well anchored” and expressed confidence that the pace of price increases would move up toward their goal “over the medium term as resource slack diminished,” the minutes showed.
- Prices as measured by the Fed’s preferred gauge rose 1.4 percent in September from a year earlier and haven’t exceeded the Fed’s target since March 2012.
- Inflation remains low even as the labor market strengthens.
- Unemployment dropped last month to a more than six-year low of 5.8 percent, close to the level that most policy makers consider full employment.
- Employers added 214,000 workers in October, keeping job growth on pace for the best annual gain in 15 years.
At the same time, some measures of labor-market health continue to show weakness. More than 7 million Americans are working part time because they can’t find full-time jobs. Of those who don’t have jobs, 32 percent have been unemployed for six months or more.
While policy makers last month “pointed to a somewhat weaker economic outlook and increased downside risks in Europe, China, and Japan,” they judged that the impact on the U.S. economy is “likely to be quite limited.”
The minutes showed a wide-ranging debate over whether to retain the committee’s pledge to keep interest rates near zero for a “considerable time.” The panel ultimately adopted the suggestion from some participants to add wording emphasizing the timing on rate increases would depend on incoming economic data.
Summary: With asset purchases program ended and the Fed looking at an early interest rate hike, inflation has became a key factor to determine if the U.S. economy is still able to sustain growth without stimulus. Economic data that contributes to inflation will have an impact on the dollar as that indirectly affects Fed’s decision on interest rate hike.