Inflation will rise to near 3 percent this year as the Federal Reserve makes unemployment its top priority, believing it can tackle potential price increases with monetary policy, according to Barclays PLC’s Michael Pond.
“The core Federal Open Market Committee voters are all for risking higher inflation in order to get the unemployment side of their mandate closer to where they want it to be,” Pond, co-head of interest-rate strategy at the bank’s Barclays Capital unit in New York, said in a radio interview on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt. “We think core inflation continues to move up towards three percent to the end of this year.”
Year-over-year core inflation rose 2.2 percent in February, the U.S. Labor Department reported March 16, the seventh straight month over 2 percent and the longest such streak since November 2008. During those seven months, the unemployment rate fell to 8.3 percent from 9.1 percent. The Fed’s goal is 5.5 percent, Pond said.
The 10-year break-even rate, a measure of inflation expectation derived from the difference between 10-year notes and Treasury Inflation Protected Securities, climbed to 2.42 percent today, the most since August.
“One of the things we have seen is a big pick-up in inflation expectation the last couple weeks with the economy showing signs of continued life and the Fed keeping its foot on the gas pedal,” Pond said. “Not pressing down harder, but not putting on the brakes.”
The Fed is willing to risk higher inflation, Pond said, because an environment with high inflation and low unemployment is easier to fix through monetary policy.
“When inflation is high, monetary policy is very easy for them -- they simply raise rates until they crush the economy enough that inflation comes down,” he said. “When it is too low and you’re at a fed funds rate of zero percent, you just experiment. They want to get in their comfort zone.”
The central bank has kept its overnight-lending rate between zero and 0.25 percent since Dec. 2008, while buying $2.3 trillion of securities in two rounds of so-called quantitative easing in a bid to boost the economy. The Fed is also replacing $400 billion of shorter-term Treasuries with longer-term debt in a program known as Operation Twist, due to end in June.
There is concern that because so much money has been pumped into the market by the central bank that inflation could become very elevated, as much as “6, 7, 18 percent,” Pond said. Inflation levels are remaining low due to the lack of velocity, or spending, in the economy, he said.
“The Fed can put as much money as it wants out there, but if people put that in bank accounts or banks park it in reserves, it won’t cause massive inflation,” he said. “Once the economy picks up, the velocity of money will increase, and that’s when the Fed could let the inflation cat out of the bag.”
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