Fed Probably Will Skip Rate Increase Next Month: John M. Berry
Aug. 9 (Bloomberg) -- Now it's wait and see.
Federal Reserve officials yesterday left their target for the overnight lending rate unchanged at 5.25 percent, hoping that it is already high enough eventually to bring core inflation back to an acceptable level.
Fed Chairman Ben S. Bernanke and his colleagues will watch the tug of war between slowing economic growth and still sizeable inflationary pressures to see whether they may need to raise the target again after this pause.
For now, the best guess is probably that there won't be a rate increase next month.
Yesterday marked the first time since May 2004 that the Federal Open Market Committee met without raising the target.
``The committee judges that some inflation risks remain,'' the FOMC statement issued after the meeting said. ``The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.''
In other words, the Fed isn't necessarily done.
Still, it was pretty clear from other parts of the statement that a majority of the committee thinks slower growth and the lagged effect of previous rate increases will do the job. One member, Jeffrey M. Lacker, president of the Richmond Federal Reserve Bank, dissented in favor of another 25 basis-point increase in the target.
``Inflation pressures seem likely to moderate over time, reflecting contained inflation expectations and the cumulative effects of monetary policy actions and other factors restraining aggregate demand,'' the statement said.
Lower Growth Forecast
Shortly before the FOMC announcement, Macroeconomic Advisers LLC, whose forecasts are closely watched by most Fed officials, reduced its estimate for third-quarter growth to a 2.4 percent annual rate, just a notch below the 2.5 percent second- quarter rate, which was lower than many economists had expected.
Meanwhile, an expanding group of well-known economists is voicing concerns that not just slower growth -- which the Fed has welcomed -- but an economic slump may lie ahead.
Economist Nouriel Roubini of the Stern School of Business at New York University said the ``recent flow of dismal U.S. economic indicators'' has convinced him ``that the odds of a U.S. recession by year-end have increased from my previous 50 percent to 70 percent now.''
His comments were posted yesterday on the Web site of Roubini Global Economics.
``The housing slump is becoming a real bust; oil is headed higher and higher and could be soon well above $80; and inflation -- both core and headline -- is rising further, forcing policy makers across the world to increase interest rates. Housing alone is now enough to cause a severe U.S. recession,'' Roubini said.
Recession or Worse?
And J. Bradford DeLong, an economist at the University of California at Berkeley, said recently on his Web site, ``With interest rates and oil prices rising and consumers spending beyond their means, we may be headed for recession -- and worse.''
Roubini argues that a slump in the U.S. will quickly cause growth to slow in other parts of the world.
Well, Fed officials recognize there are substantial risks ahead, particularly given the pressure of high energy prices on both inflation and consumer spending. None of them is expressing concern that a recession is likely.
Consumer spending rose at a 2.5 percent annual rate in the second quarter, well below the average in recent years and it may be even weaker in coming months. Personal income gains from wages and salaries may taper off as the number of payroll jobs created each month eases, along with the number of aggregate hours worked.
Financial Distress
Meanwhile, home equity borrowing is no longer increasing as interest rates have gone up and housing prices have begun to turn down. Some analysts have also pointed to a sudden spurt in revolving consumer credit -- essentially credit-card balances -- at an annual rate of 11 percent in May and 9.8 percent in June, as evidence of some financial distress among households.
Nevertheless, Fed officials are generally sticking by their collective forecasts of slower, but still solid, growth in the second half of the year, though they have to be somewhat troubled by the unexpected dip in business investment in new equipment and software in the second quarter.
On the inflation front, they can't be very happy either with yesterday's report from the Labor Department that unit labor costs rose at a 4.2 percent annual rate in the second quarter at non-farm businesses. That meant they were up 3.2 percent over the 12 months ended in June.
What Will It Take?
Officials probably will discount that unit labor-cost figure because it was based on an increase in compensation per hour at a 5.4 percent rate, well above the increase shown by the employment cost index, which was about 2 percentage points less for the quarter.
At this point, Fed officials appear to be much less worried about inflationary pressure arising from labor costs than some private-sector analysts are.
So what would it take to cause officials to resume raising the overnight lending rate when the FOMC next meets in late September?
Signs of a sharp rebound in economic growth combined with added inflationary pressures probably would do it, though such a rebound appears unlikely at the moment.
A large increase in inflation expectations might also push the Fed in that direction, depending on what seemed to be the reason for such an increase.