Fed keeps focus on inflation

Fed keeps focus on inflation
By Krishna Guha in Washington
Copyright The Financial Times Limited 2007
Published: May 9 2007 19:24 | Last updated: May 9 2007 20:23


The Federal Reserve made very few changes to its policy statement on Wednesday, keeping rates on hold at 5.25 per cent and reiterating that its “predominant policy concern remains the risk that inflation will fail to moderate as expected.”

The policy-making Federal Open Market committee again described core inflation as “somewhat elevated”, in spite of the dip in core inflation on its preferred measure in March to 2.1 per cent year on year.

This description will disappoint some investors, who were looking to the Fed to hint that the risks of inflation remaining at an uncomfortably high level have receded since the previous policy meeting in late March.

Equities traded broadly flat after the announcement, while the dollar edged up a fraction against the euro, with traders citing a reduced likelihood of early Fed rate cuts.

Futures markets priced in a slightly reduced chance of rate cuts at subsequent meetings this year, with the market now assuming only a single rate cut by year end.

The FOMC did acknowledge that “economic growth slowed in the first part of this year” and that the adjustment in housing was “ongoing”.

But it reiterated its view that “nevertheless, the economy seems likely to expand at a moderate pace over coming quarters.” Moderate pace in the Fed’s lexicon appears to mean growth of roughly 2 per cent.

The statement appears consistent with a policy of interest rates on hold for some time. As at the previous meeting, however, the Fed implicitly signalled that it was concerned about growth as well as inflation.

It said “future policy adjustments” – by implication, interest rate moves in either direction – “will depend on the outlook for both inflation and economic growth.”

The statement was probably on balance slightly more hawkish than most economists were expecting. It did not acknowledge any increased risk from housing in the light of early data from the spring selling season; nor did it suggest that inflation concerns have been substantially moderated by a combination of March’s softer inflation report and April’s weaker payrolls gain.

Policymakers are likely to want to see more evidence of moderating inflation reading and softer jobs growth before shifting to a neutral policy stance.

Moreover, it is not entirely clear how the Fed would respond to moderately softer data. Some committee members, who appear anxious to drive inflation down towards 1.5 per cent in the none-too-distant future, might welcome the added disinflationary impetus.

Others, who could apparently live with inflation a fraction below 2 per cent for at least a lengthy period of time, might prefer to respond to further soft data by taking the opportunity to cut rates to restore growth to trend more quickly.