Rising energy costs will probably provoke concern among Federal Reserve officials this week that consumers and businesses will pull back on spending and slow the U.S. recovery, said economists such as Lou Crandall at Wrightson ICAP LLC.
The more than 9 percent increase in crude oil prices this year may leave consumers with less money to spend on other goods and boost corporate costs, curbing outlays for staff, plants and equipment. To the Fed, the threat of a flagging recovery may appear to be a bigger risk than inflation, Crandall said. Policy makers say achieving self-sustaining growth is vital before they begin to withdraw record monetary stimulus.
“The Fed is going to be worried about a soft patch in the near term,” said Crandall, Wrightson ICAP’s chief economist, who is based in Jersey City, New Jersey. While Fed officials will be prepared to react to inflation, “the high cost of a downside surprise in growth probably trumps everything else.”
The Federal Open Market Committee at the conclusion of a meeting tomorrow will probably affirm its commitment to buy $600 billion in Treasury securities through June, said Roberto Perli, a managing director at International Strategy & Investment Group in Washington. Persistent uncertainty about the staying power of private spending and investment would likely prompt Fed officials to maintain a neutral policy for several months by reinvesting proceeds from maturing bonds rather than letting them run off, said Perli.
Such an approach would keep the central bank’s balance sheet close to its current level. The Fed’s total assets stand at a record $2.58 trillion.
“Rising oil prices can affect both headline inflation and output growth,” said Perli, formerly an economist at the Fed’s Division of Monetary Affairs. If oil prices stay high, “the Federal Open Market Committee would most likely react by maintaining an easy stand for longer than it would have otherwise unless inflation expectations rise.”
Consumer confidence fell to the lowest level in a month as surging gasoline prices soured Americans’ outlook about their finances and the economy. The Bloomberg Consumer Comfort Index dropped to minus 44.5 in the week to March 6 from the prior week’s minus 39.7.
Consumers this month expected an inflation rate of 4.6 percent over the next 12 months, the highest level since August 2008, compared with 3.4 percent in February, according to a Thomson Reuters/University of Michigan survey.
Still, companies such as Cincinnati-based Kroger Co., the largest U.S. grocery-store chain, may have trouble passing higher costs on to consumers whose income growth is limited.
“Unemployment is high in most of our markets, and food stamp use continues at its peak,” Kroger’s Chief Executive Officer David Dillon said on a March 3 earnings call. “Rising food prices and fuel prices will affect customer spending behavior.”
The increase in oil prices coincides with other forces inhibiting economic growth, including waning fiscal stimulus and reductions in spending by federal, state and local governments.
Macroeconomic Advisers LLC, the St. Louis forecasting firm, estimates that tighter fiscal policy will subtract nearly 1 percentage point from growth in U.S. gross domestic product in 2012. The economy will expand 3.5 percent from the fourth quarter of 2011 to the fourth quarter of 2012, instead of 4.5 percent, according to the firm’s estimates.
Costlier oil is also prompting downward revisions in the outlook. Economists at New York-based JPMorgan Chase & Co. on March 11 cut their first-quarter estimate for annualized growth by a full percentage point, to 2.5 percent, and their second- quarter outlook to 3.5 percent from 4 percent partly because of higher energy costs.
“The consumer is a little bit of a worry here, and there is a question of whether the fundamentals are lining up for good growth in spending,” said Michael Feroli, chief U.S. economist at JPMorgan Securities.
Goldman Sachs Group Inc. economists say a 20 percent rise in crude oil prices beyond the firm’s forecast of $105 a barrel in the second quarter could shave as much as a 1 percentage point off of the economy’s annual growth rate by late 2011 or early 2012, while raising the rate of core inflation no more than 0.2 percentage points on an annual basis.
Oil for April delivery fell to $101.16 a barrel on the New York Mercantile Exchange last week, the lowest since March 1, on concern the earthquake in Japan would limit demand. Prices are up 25 percent from a year ago.
Easier Than Otherwise
“If higher oil prices slow growth but do little to core inflation, it follows that Fed policy will tend to be easier -- not tighter -- than otherwise,” said Andrew Tilton, an economist at New York-based Goldman Sachs. “All this suggests that the Federal Open Market Committee will be in no frame of mind to tighten financial conditions with its Tuesday statement.”
A decline in the stock market could also erode consumer confidence and spending, said Dan Greenhaus, chief economist strategist at Miller Tabak & Co. LLC in New York.
The S&P 500 has fallen 2.9 percent from this year’s high on Feb. 18 as oil surged amid unrest in the Middle East.
“If you end up in a situation where the stock market ceases to appreciate without a commensurate pickup in wage growth, the economy could run into a stall,” Greenhaus said.
Policy makers can’t count on consumers to borrow to support their spending, said Ward McCarthy, chief financial economist at Jefferies & Co. Inc. in New York.
“We are not going to enter a new era of leveraged consumer spending, and that is what you would need right now if you were going to get a big kick in consumption,” he said.
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