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Food, fuel prices unlikely to shake Fed from path


Reuters

The Federal Reserve will continue to focus on low underlying inflation in pushing aggressive measures to support the U.S. recovery, even as European authorities fret about rising energy and food prices.

With the U.S. economy only now emerging from a period of inflation so low that policy makers were worried about the risk of a damaging downward spiral of falling prices, the Fed, which opens a two-day meeting on Tuesday, is on a different track than the European Central Bank.

Comments by ECB President Jean-Claude Trichet over the weekend urging central banks to pay attention to inflationary threats from rising commodity prices led many to believe the ECB may be moving toward rate hikes.

Trichet emphasized overall inflation, rather than the “core” measures favored by the Fed that strip out volatile food and energy costs.

Surging global food prices are a problem more broadly for emerging markets already battling inflationary pressures, and French President Nicolas Sarkozy has made food price spikes a theme the Group of 20 leading rich and emerging economies will tackle this year.

It’s not that officials on the Fed don’t worry about headline inflation; some of them may even see rising gasoline or wheat prices as warning signs.

But with a sluggish recovery barely chipping away at a U.S. unemployment rate that has remained stubbornly above 9 percent, policy makers will see no reason to tap the brakes until core inflation ticks higher.

“While the Fed may identify higher commodity prices as a potential concern, policy makers are not likely to reverse course and tighten policy unless higher commodity prices push through to core inflation,” University of Oregon economics professor Tim Duy wrote on his blog. “Such an outcome appears unlikely given persistently high unemployment.”

The Fed Biding Its Time

The Fed, which kicks off its first meeting of the Federal Open Market Committee this year with a new roster of voting members under its rotating system, could soften its characterization of underlying inflation to nod to an apparent stabilization after a long period of slowing in its post-meeting statement on Wednesday. But officials are unlikely to raise alarm bells even as food and energy prices mount.

Fed officials have long focused on core price measures because they see those gauges as better predictors of where inflation is heading.

In contrast, the ECB, a newer institution in a region where inflation has had socially disastrous consequences, believes it’s important to focus on headline inflation to help keep expectations of future price gains in check.

“Purists – or at least the people in the Fed camp – would say that monetary policy is most capable of controlling the core components and is less capable of controlling movements in commodity or food prices,” said Michael Gapen, a senior U.S. economist at Barclays Capital who was formerly with the Fed.

Trichet is looking at headline euro zone inflation that surged 2.2 percent in the 12 months through December, the first time in more than two years that it topped the ECB’s target of below, but close to 2 percent.

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