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Fed, in shift, may move to faster pace of rate hikes

EconomyMar 14, 2017 01:10AM ET
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© Reuters. FILE PHOTO - A police officer keeps watch in front of the U.S. Federal Reserve in Washington

By Ann Saphir and Lindsay Dunsmuir

SAN FRANCISCO/WASHINGTON (Reuters) - The Federal Reserve, which has struggled to stoke inflation since the financial crisis and up until now raised rates less frequently than it and markets expected, may be about to hit the accelerator on rate hikes.

On Wednesday, the U.S. central bank is almost universally expected to raise its benchmark interest rates, a move that just a few weeks ago was viewed by the markets as unlikely.

And with inflation showing signs of perking up, Fed policymakers may signal there could be more than the three rate rises they have forecast for this year.

"They do not have as much room to be patient as they did before," said Tim Duy, an economics professor at the University of Oregon, who expects Fed policymakers to lift their rate forecasts this week.

Policymakers have their eyes on achieving full employment and 2-percent inflation. The faster the economy approaches those goals, Duy said, the quicker the Fed will want to tighten policy to avoid getting behind the curve.

"That's an acceleration in the dots," he said, referring to forecasts published by the Fed that show policymakers' individual rate-hike forecasts as dots on a chart.

The economy already appears closer to its goals than the Fed had expected in December, the last time it released forecasts. The jobless rate, at 4.7 percent, is below what policymakers see as the long-run norm, and inflation, at 1.7 percent, is already in the range they had expected by year end.

THE LONG-WISHED FOR RETURN OF INFLATION

As Fed policymakers prepare to raise rates this week for the second time in three months, the inflation terrain they face looks steeper than it has been since the financial crisis when one of the central bank's policy aims was to generate inflation.

There are signs of more inflation globally, the dollar is pushing down less on U.S. prices, domestic inflation expectations have picked up and Friday's closely watched monthly jobs report showed wages rising 2.8 percent year-on-year in February, with payrolls rising a sturdy 235,000.

The Fed's preferred inflation measure, the so-called core PCE price index, recorded its biggest monthly increase in five years in January and was up 1.7 percent year-on-year after a similar gain in December.

Most Fed policymakers say such data gives them increasing confidence that inflation will eventually reach the Fed's goal after years of undershooting.

Inflation in the euro zone jumped to a four-year high of 2.0 percent in January, above the European Central Bank's target rate of just below 2 percent.

Oil prices have also moved higher, with the price of Brent crude oil [LC0c1] up about 30 percent from January 2016.

The 5-year forward inflation expectation rate, a market gauge tracked by the Fed, currently stands at 2.14 percent, up from 1.60 percent one year ago.

And the 10-year TIPS breakeven rate, another measure of inflation expectations tracked by the Fed, last month reached its highest levels since September 2014.

Fed Chair Janet Yellen said earlier this month she doesn't believe the Fed is behind the curve on inflation.

To inflation hawks like Richmond Fed President Jeffrey Lacker, the Fed is already in danger of falling behind. But even centrist policymakers like the San Francisco Fed's John Williams see receding risks of persistently too-low inflation and the potential need for swifter rate hikes.

"The inflation risks are pretty clearly tilted to the upside," said Eric Stein, a portfolio manager for Eaton Vance in Boston.

Fed, in shift, may move to faster pace of rate hikes
 

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