WASHINGTON: The US Federal Reserve holds its final policy meeting this week facing a conundrum most countries would love to have: slowly accelerating economic growth with no sign of inflation.
The good signs in the US economy ironically make it harder for the Fed to move closer to what it knows it must do sooner rather than later: begin lifting the benchmark federal funds interest rate from the zero level, where it has been for six years now.
Anticipation of the move has riveted markets for two years, feeding into volatility in stocks and bonds and sharp shifts in currency markets.
The two-day meeting will amount to an update to markets about where the Fed stands on its indicated plan to begin raising rates around mid-2015.
No major policy announcements are expected. The Federal Open Market Committee (FOMC) could make a modest change in its messaging policy on the eventual rate hike.
Over the past year, it has repeatedly said that a Fed funds increase would only come a ‘considerable time’ after the end of the quantitative easing programme, which was wound up in October.
That language could be dropped for an even more opaque qualifier that would give it more flexibility, to either move quickly if growth and prices pick up unexpectedly, or hold off indefinitely if growth stalls.
To this end, one Fed official has suggested the FOMC just say it will be “patient.”
“The Fed is striving to avoid any unpleasant market surprises,” said IHS Global Insight in an analysis.
The central bankers will need patience to decide what exactly the data is telling them.
US economic growth over the past two quarters has been the strongest since 2003. The fourth quarter looks strong as well.
November job creation stunned with a high 321,000 new jobs, underscoring the sharp 1.2-point fall in unemployment over the past year to 5.8 per cent.
Retail sales in November, the kickoff to the holiday shopping season, were strong, up 5.1 per cent from a year earlier.
That trend is expected to even strengthen with the sharp fall in gasoline prices, enough to add a US$700 or more annual boost to the average family’s spending power.
“Retail sales in the fourth quarter are so far running one per cent higher than the third quarter on average, suggesting consumer spending will help drive yet another healthy GDP increase in the final quarter of the year,” said Chris Williamson of Markit.
But after having helped bring the unemployment rate down, the FOMC wants to see inflation up around two per cent to confirm the economic recovery. So far, prices are not cooperating.
Recent data shows deflationary pressures, partly driven by the fall in oil and other commodity prices, and partly by the slower growth in China, Europe and Japan.
A key inflation indicator, the producer price index, showed a 0.2 per cent fall in November. The main reason was the steep drop in energy prices, which the Fed does not weigh much when assessing inflation.
But wholesale prices stripping out energy also fell, for the second straight month, by 0.1 per cent.
And year-on-year overall producer prices were up 1.4 per cent, the slowest rate of annual increase since January.
Without pressure from inflation, the Fed has little need to advance plans for a rate increase.
The one key variable in focus is wages. Pay for Americans has gone nowhere in the recovery.
An uptick in wage growth would more clearly signal firm growth and that the economy would not suffer from higher interest rates.
Widely noted in November’s jobs market data was an uptick in hourly wages that, if sustained for a quarter or more, would likely be seen as proof of that strength.
But without that confirmation for the moment, analysts expect the FOMC to remain patient, and are sticking to the existing forecasts.
“Quite a few Fed officials are looking at the June 2015 meeting as the appropriate time for the initial rate hike, and we concur that this is the most likely scenario,” said IHS. — AFP