Slow Inflation: Warning Signal

Photograph by Andrew Harrer/Bloomberg

A sale sign at a retail store in the Georgetown neighborhood of Washington, D.C.

Falling prices may sound good to the U.S. consumer, but Federal Reserve policy makers may be cringing at figures this morning showing that inflation has slipped further below their 2 percent target.

The personal consumption expenditures price index, the Fed’s preferred gauge of the price stability side of their dual mandate, rose 0.7 percent in the 12 months to April, the slowest year-over-year gain since October 2009.

The data, released by the Commerce Department today, are an unwelcome sign for the Fed as it prepares to meet June 18-19 and discuss possible changes to the unprecedented accommodation measures it’s implemented to boost the recovery. The Federal Open Market Committee announced May 1 that it will increase or decrease the pace of its monthly bond purchases in response to changes in inflation and the labor market.

“The Fed is likely to lean toward keeping QE in place and full-sized for the time being,” Christopher Low, chief economist at FTN Financial in New York, said in a research note. “Super-low inflation will make the decision even easier, even if it is the product of excessive austerity in Europe.”

While a further ramp-up in asset purchases is unlikely, the inflation news does “give the Fed considerably more latitude as to when it opts to scale back the pace of asset purchases,” Richard Moody, chief economist at Regions Financial Corp. in Birmingham, Alabama, said in a research note. “This is not insignificant, given the Fed’s greater fear now is pulling back too soon rather than too late.”

Some policy makers already have warned this month that continued restraint in prices may become a more serious problem for the expansion, while there are still varying perspectives on the committee as to how the central bank should respond.

Failure to address low inflation could put the U.S. on the path of Japan, where deflation, or a general decline in prices, has become “quite difficult to reverse,” Boston Fed chief Eric Rosengren said in May 16 remarks in Milan. Prices lingering below the Fed’s 2 percent target may mean policy “has not been sufficiently accommodative,” he said.

St. Louis Fed President James Bullard said May 23 in London that more disinflation, which is a slowing in the rate of price increases, could prompt additional asset purchases by the central bank. Charles Evans, head of the Chicago Fed, said May 9 that inflation is “too low,” though “it’s too early” to respond with a policy shift.

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