Business | Economy
Federal Reserve sounds inflation alarm
Officials keep options open on rate changes in case the credit crisis worsens and economy deteriorates.
- Bloomberg
- Published: 00:07 June 27, 2008
Washington: The Federal Reserve is sounding the alarm on inflation without committing to raising interest rates.
The Federal Open Market Committee (FOMC) left its benchmark rate at 2 per cent on Thursday and said "upside risks" to prices have picked up. The statement also said consumer spending is "firming," while acknowledging that rising energy prices will curb growth into 2009.
The FOMC cited "the elevated state" of some measures of inflation expectations and dropped an April forecast of a "levelling out" in commodity prices. The officials want to keep their options open on rate changes in case the credit crisis worsens and the economy deteriorates after consumers spend their tax rebates, Fed watchers said.
"It is a baby step in the direction of raising rates," said Stephen Stanley, chief economist at RBS Greenwich Capital Markets in Greenwich, Connecticut. The central bankers signalled "they are not expecting to tighten in the near term. That is as far as they are willing to go," he said.
Treasuries fell, with the yield on the benchmark 10-year note rising 3 basis points to 4.12 per cent as of 7:27am in London.
The FOMC also said employment had weakened and financial markets remained under "considerable stress," even as growth risks "diminished somewhat."
Concern
Chairman Ben S. Bern-anke and his colleagues stopped short of specifying that inflation was a greater concern than growth. They reiterated language from their April meeting that the Fed will "act as needed" to promote both economic expansion and stable prices.
Traders trimmed bets on a rate increase in the next three months after the announcement. Odds that the Fed will keep its benchmark at 2 per cent in Sep-tember jumped to 66 per cent from 10 per cent a day earlier, according to futures contracts quoted on the Chicago Board of Trade.
"I don't think they are signalling a rate hike as a possibility at the next meeting," said Cary Leahey, senior economist at Decision Economics Inc. in New York. "Before they would tighten credit, they would have a statement that would say 'we do have a tightening bias' and they would say that as clearly as they can."
Thursday's statement reflected Fed officials' comments this month that the central bank must keep price expectations in check to avoid a spiralling in inflation. Bernanke said June 9 that officials would "strongly resist" a jump in those expectations.
The decision wasn't unanimous, with Dallas Fed President Richard Fisher dissenting for a fourth straight time, favouring the first rate increase in two years.
American consumers foresee average annual inflation of 3.4 per cent over the next five years, the highest expectation since 1995, according to the Reuters/University of Michigan survey.
"What they [Fed] are saying is, we have a duty to price stability, and we want you to know that we are mindful of that duty, but we may not think it's appropriate to act on that duty in the short run," said Neal Soss, chief economist at Credit Suisse in New York, who used to work as an aide to former Fed chief Paul Volcker.
Credit markets have yet to normalise and bank losses are mounting as the economic slowdown adds to stresses from the subprime mortgage collapse. The gap between investors' expectations for the Fed's main rate and the rate that banks charge each other for funds increased this month, a sign of continued turmoil.
What they [Fed] are saying is, we have a duty to price stability, and we want you to know that we are mindful of that duty, but we may not think it's appro-priate to act on that duty in the short run."
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