Call it Janet Yellen’s pre-emptive strike.
On Tuesday, the Federal Reserve chair laid out the case for why this year’s unexpected inflation slowdown shouldn’t be too concerning. Three days later, a report showed price gains drifting further from the central bank’s target, but investors still saw a December rate hike as likely.
The Federal Open Market Committee’s primary inflation measure, which is tied to consumer spending, rose a below-forecast 1.4 percent in the year ended in August, Commerce Department figures showed Friday. Excluding food and energy prices, core inflation slowed to 1.3 percent, the smallest gain in nearly two years.
“Yellen was pretty clear that something may be different about inflation but the laws of economics have not been reversed,” said Mark Vitner, a senior economist at Wells Fargo Securities LLC in Charlotte, North Carolina. “The labor market is tightening and they are not giving up on the view that inflation will be moving back to the 2 percent goal. Surprisingly low inflation will probably give way to some upside surprises in 2018.”
The odds of a quarter-point interest-rate hike by December have risen in recent days to about two-thirds, based on fed funds futures, and remained steady on Friday in the wake of Friday’s data.
Yellen, speaking in Cleveland to the National Association for Business Economics, said “low inflation likely reflects factors whose influence should fade over time.” While the Fed’s understanding is “imperfect,” the uncertainty “strengthens the case for a gradual pace of adjustments” in interest rates, she said.
The FOMC is focused mainly on overall inflation. Core inflation, though, tends to give a better indication of where prices are headed because it’s less volatile. It also mitigates the impact from recent hurricanes, which have pushed up prices at the gasoline pump.
The Commerce Department said that Friday’s spending and income data reflect the effects of Harvey, which made landfall in late August along the Gulf Coast in Texas. It didn’t give specific estimates of the impact on purchases or prices.
Even with Yellen’s comments, the inflation slowdown may test policy makers’ faith that price gains will soon accelerate.
“From the Fed’s perspective, this is not what they wanted to see,” said Gus Faucher, chief economist at PNC Financial Services Group Inc. in Pittsburgh. “The slowing in core inflation is a disappointment. If it gets toward the end of 2017 and it looks like core inflation is not picking up, that could cause the Fed to hold off.”
Several FOMC participants have expressed concern about falling inflation. Philadelphia Fed President Patrick Harker said Friday that while he’s “penciled in an increase” in rates at the end of the year, “inflation is the one area” that “gives me pause.” In his speech at an event hosted by his bank, Harker noted that the latest PCE price data were weak.
St. Louis Fed President James Bullard, who’s been opposed to another hike this year, said in a speech Wednesday that “U.S. inflation has surprised to the downside in recent months, and the surprise is unlikely to reverse during 2017.”
If it doesn’t, the December debate will get more heated among FOMC participants by then.