Playing Patience With The Fed

By Justin Lahart 

        The Federal Reserve says it can be patient. Considering where inflation is headed, it may have to be.
        Following its policy-setting meeting Wednesday, the central bank tweaked its language on rates, opting to drop an assurance that they can stay low for a "considerable time." Instead, the Fed said it "can be patient in beginning to normalize the stance of monetary policy."
        This was a long-awaited change meant to prepare markets for the increase in short-term interest rates that most forecasters believe will begin in the middle of next year. But given where falling energy prices are pushing inflation, a later monetary-policy liftoff date is looking more likely.
        Indeed, the Labor Department on Wednesday said its index of consumer prices was just 1.3% above its year-earlier level in November, after rising 1.7% in October. Much of that softening had to do with what has happened at the pump--gasoline prices, which make up about 5% of the index, were down 11% from a year earlier. Gasoline has fallen further since then, with regular falling to $2.55 a gallon on Monday from an average price of $2.91 in November. And it looks to have further to fall, with futures pointing to $2.24 early next year.
        A back-of-the-envelope calculation--using that gasoline price, an assumption that prices for energy services such as electricity stay flat with their November level, and that other goods and services change at the same year-over-year rates as in November--suggests that will send the consumer-price index below its year-earlier level by February. And if gasoline prices don't recover, the CPI could still be negative at midyear. The Fed's preferred measure of inflation--a Commerce Department index of consumer prices--would likely be in negative territory as well.
        The Fed's instinct is to look at core inflation measures, which exclude volatile food energy prices and so better reflect inflation's underlying trend. But raising rates when headline inflation was running negative could be very difficult. Moreover, there may be some pass-through from energy into other prices, while a stronger dollar and weak overseas growth looks to put pressure on prices for imported goods.
        There is, though, a flip-side to the impact on inflation from declining energy prices. That is its effect on real, or inflation-adjusted, growth. The Fed may be about to face an environment where the economy has really started to cook, but raising rates is still unappetizing.
        (END) Dow Jones Newswires

        December 17, 2014 17:18 ET (22:18 GMT)

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