Fed Likely to Remain Cool on View of Economy

Sunday, 23 Jan 2011 07:22 PM

 

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Federal Reserve Chairman Ben Bernanke may have to muffle his applause for the sturdier U.S. economic recovery.

The unemployment rate is finally edging lower and figures due Friday are expected to show economic growth strengthened over the final three months of 2010. But the Fed may provide only a slightly more upbeat economic assessment at its next policy-setting meeting, which wraps up Wednesday.

The central bank's word choices are always parsed and scrutinized. This week's statement will be particularly tricky because the Fed will need to acknowledge the improving economic data without sending a false signal that its $600 billion bond-buying program could end early.

But if Bernanke and company are too sparing in describing the recovery's progress, that could be interpreted as a lack of faith that this latest burst of economic vigor will last.

At its last meeting, in December, the central bank said the economic recovery was continuing but at too sluggish a pace to bring down unemployment, and the high jobless rate was weighing on consumer spending.

The jobless rate, however, dipped to 9.4 percent in December from 9.8 percent the previous month, still well above normal but down considerably from a cycle peak of 10.1 percent hit in October 2009.

As for consumer spending, it appears to have grown at a nearly 4 percent annual rate in the latest quarter.

"A key question is whether the Fed modifies its description of spending or looks past the data and maintains its downbeat view," said Barclays Capital economist Dean Maki.

"The latter would suggest that its views will be difficult to change," he said.

Maki said the central bank may find a middle ground by upgrading its description of spending growth, perhaps to "solid" from "moderate."

Likewise, the Fed could read the December dip in the unemployment rate as little more than monthly volatility or a promising sign.

Maki said officials may want to preserve some flexibility for now, perhaps by saying the rate of recovery was not robust enough to bring down unemployment "in a sustained way."

The Bank of Japan also holds a policy-setting meeting this week. Like the Fed, it is widely expected to keep interest rates unchanged near zero. Unlike the Fed, it is grappling with negative readings on key inflation gauges.

Economists polled by Reuters think Japan's consumer price index will show a 0.1 percent decline year-on-year. Excluding food and energy costs, core inflation is expected to be down 0.5 percent. The figures are due on Thursday.

UNEMPLOYMENT AND INFLATION?

In the United States, the high unemployment rate is the primary reason why the Fed is in no hurry to raise interest rates, even though the economy appears to be generating above-trend growth.

Economists polled by Reuters think Friday's report on U.S. fourth-quarter gross domestic product will show the economy expanded at a 3.6 percent pace, up from the third quarter's 2.6 percent rate. Some of the more bullish forecasters are looking for a reading above 5 percent.

Forward-looking indicators, including the Economic Cycle Research Institute's measure of future growth, suggest the pace of growth will continue to strengthen in the coming months. Many economists upgraded their 2011 assessments after the White House agreed to keep lower tax rates for everyone instead of only for those earning less than $200,000 a year.

Unemployment is also the main argument used by those who say the global spike in food and energy costs won't translate into a broader bout of U.S. inflation.

Friday's report on employment costs is expected to show a growth rate of just 0.5 percent, slightly faster than in the third quarter but still nothing worrisome.

Harm Bandholz, chief U.S. economist with UniCredit Research in New York, said that could change, even if unemployment stays high. Wages may not rise, but other labor costs could. He cited a survey by the Philadelphia Fed showing businesses expected an 8.6 percent jump in healthcare benefit costs this year.

While Bandholz does not think the Fed will raise interest rates until mid-2012, he suspects two well-known inflation "hawks" on the Fed's policy-setting committee will dissent against the Fed's policy stance, perhaps as early as this week's meeting.

Charles Plosser, the Philadelphia Fed president and one of the most likely candidates to dissent, said recently he considered price stability the Fed's most important objective.

"For most of his colleagues, that thinking is probably too European," Bandholz said, a reference to the European Central Bank's single mandate to tame inflation.

But if the economy continues to generate above-trend growth and inflation pressure builds, the debate inside the Fed will grow louder.

© 2014 Thomson/Reuters. All rights reserved.

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