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Bernanke Seen Accepting Faster Inflation as Fed Seeks to Boost Employment

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Source: Bloomberg

Federal Reserve Chairman Ben S. Bernanke spent six years pushing for an inflation goal. Now that he has it, some investors are betting he will breach the 2 per cent target in the short run to lower unemployment.

The Fed chairman told lawmakers last week that an increase in energy costs will boost inflation “temporarily while reducing consumers’ purchasing power.” He also said the central bank will adopt a “balanced approach” as it pursues its twin goals of price stability and full employment, which it defines as a jobless rate of between 5.2 per cent and 6 per cent.

“The chairman seemed to suggest they will tolerate a misdemeanour on inflation as unemployment continues to fall toward their goal” over several years, said Mark Spindel, chief investment officer at Potomac River Capital, a hedge fund that manages US$250 million in Washington.

Policy makers at a March 13 meeting probably will not deviate from their commitment to hold the main interest rate close to zero at least through late 2014, even if their forecast shows a burst of energy-driven inflation, said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. They will probably be more concerned that rising prices will hold back real spending, impeding growth and improvement in the job market, he said.

“The chairman said, ‘We think it is transitory, we are sticking to our guns, we are going to focus on the drag on income,’” Crandall said. Bernanke explained in his testimony how under a strategy of flexible inflation targeting, “a temporary spike in the price indexes can be a reason for the central bank to be more generous rather than less,” Crandall said.

Crude oil prices have risen 32 per cent since the end of the third quarter of 2011 and 6 per cent this year. Energy prices could hold the Federal Open Market Committee’s inflation target benchmark, the personal consumption expenditures price index, above the Fed’s 2 per cent inflation objective for much of 2012, Crandall said. The PCE rose 2.4 per cent for the 12 months ending in January.

The FOMC will probably acknowledge the increase in energy costs in its March 13 statement, while noting that long-term inflation expectations are stable, as they did in March last year, said Antulio Bomfim, senior managing director at Macroeconomic Advisers LLC in Washington and a former Fed staff economist.

Higher energy costs “put upward pressure on inflation, but it is also a tax on consumers,” Bomfim said. “It is not clear that inflation is going to be their main concern next week.”

Also, workers have weak leverage for increasing wages to compensate for higher costs. Real average weekly earnings have fallen for 10 consecutive months on a year-over-year basis. As energy costs eat up more of consumer expenditures, companies have difficulty raising prices on other goods and services.

“Higher prices have taken a toll on all customers,” W. Rodney McMullen, president and chief operating officer of Cincinnati-based Kroger Co, the largest US grocery chain, said on a March 1 investor call.

Labour’s weak bargaining power partly stems from an unemployment rate that probably did not budge last month from the 8.3 per cent level of January, according to a Bloomberg News survey of economists. The Labor Department plans to release its monthly report on employment on March 9.

Bernanke in February 29 testimony in Congress said the Fed’s emphasis on inflation or employment depends on the “magnitudes of the deviations” of each goal from the targeted rate and the time expected before the indicators align with the central bank’s objectives.