Inflation ‘Overshoot’ Concerns Fade Into the Sunset as Powell Projects Rate Hikes
(Bloomberg) -- The Federal Reserve spent early 2018 assuring investors it wouldn’t fret if inflation climbed above its 2 percent target. That possibility now looks increasingly distant.
Oil prices have slumped, weighing on expectations. Housing, a big inflation contributor throughout this cycle, is cooling. And while the core version of the Fed’s preferred price index touched 2 percent this year, Fed research found that potentially fleeting factors drove the increase. Commerce Department data published Friday showed that core inflation came in at 1.9 percent in the year through November -- close to, but still shy of, the Fed’s goal.
“We’re trying to be symmetrically around two percent,” Chairman Jerome Powell said of inflation on Wednesday, speaking after the Fed raised interest rates for the fourth time this year. “We’ve been close to that. We haven’t gotten there yet, and we have not declared victory.”
Notwithstanding that nod toward symmetry, the Fed’s post-meeting policy statement and economic forecasts showed little appetite for allowing prices -- stubbornly low for most of the past decade -- to rise faster than 2 percent for any substantial period.
Officials downgraded their previous expectation that core inflation would reach 2.1 percent in each of the next three years. The median policy maker now sees it at 1.9 percent this year before hovering at 2 percent for the rest of the forecast through 2021. And officials projected continued rate increases despite that benign inflation outlook, which should tamp down any price pressures that do exist.
“They aren’t going to try to engineer things going above 2 percent just in order to say, ‘Hey, we’re symmetric around our target’,” said Alan Detmeister, an economist at UBS Securities LLC and former head of the Fed’s division on prices and wages.
The Fed doesn’t officially aim to average 2 percent over time. In fact, policy makers sometimes describe symmetry as being equally unhappy about undershooting and overshooting their goal. But in practice, after being under their goal for years, they’ve talked about a period of overshooting with ambivalence.
“It’s completely fine to go above 2 percent for some time,” Chicago Fed President Charles Evans said in October. “In fact we ought to average two, be above two, half the time, perhaps.”
Those comments came when prices were gradually moving higher and an overshoot looked probable. Now, continued undershoot is increasingly likely.
The Fed has long expected tight labor markets to push prices higher. That’s been slow to materialize even as unemployment fell to its lowest level since 1969. Powell himself has chewed over whether the long-standing relationship between low joblessness and higher prices -- called the Phillips curve -- has broken down.
“There was a time when inflation reacted really quickly to changes in growth and changes in unemployment, and that time is behind us,” Powell said Wednesday. While unemployment has dropped to 3.7 percent from a post-recession peak of 10 percent, “inflation has not reacted a lot.”
What’s more, consumer inflation expectation surveys remain at the lower end of the range the Fed sees as consistent with its goal, and a commonly-watched market-based inflation expectations indicator has been dropping since September. Despite that, the Fed in its statement called expectations “little changed, on balance.”
“I thought it was absolutely the most tone-deaf thing I saw,” from the Fed’s meeting, said Omair Sharif at Societe Generale. The Fed might view the decline as transitory because it’s been spurred by slumping oil prices, he said, or they might have wanted to avoid coming off too dovish.
While the message the Fed did convey wasn’t taken as especially dovish, officials would almost certainly take note if price gains slipped significantly.
That’s because since the 1970s, investors and consumers have become convinced that price gains will be steady and moderate, and economists view that as one of the U.S. central banks’ greatest accomplishments. The Fed wants to ensure that the public continues to have faith in its willingness and ability to accomplish its goals.
“If it turns out that inflation keeps surprising to the downside, the need for aggressive hikes will come under question,” Standard Chartered Bank economist Steven Englander and his colleagues wrote in a Dec. 20 research note.
But for now, with a base-case expectation that inflation could creep slightly higher, the Fed remains focused on choking off future excess -- not on the risk of persistently undershooting its price stability goal.
“Remember when we were talking about overshoot in the summer?” said Sharif, noting that a lot of Powell’s inflation comments on Wednesday “were very much downplaying being a little below target.”
©2018 Bloomberg L.P.