US inflation retreat clouds Fed rate outlook

The US inflation rate retreated in July, in a further sign of the benign price pressures that have allowed the Federal Reserve to leave its interest rates policy unchanged all year.

By Sam Fleming

The core measure of consumer price inflation, which excludes food and energy, slipped to 2.2 per cent, down from a 2.3 per cent year-on-year rate the prior month, Labor department figures showed. Prices rose just 0.1 per cent compared with June.

On Tuesday, the New York Fed chief Bill Dudley told Fox Business Network that markets were underpricing the odds of a second rise in official interest rates, as he suggested a move could come as soon as next month.

But given the sluggish performance of inflation and the hesitancy the Fed has displayed all year, traders will need firmer signals from the central bank before they begin to price in a significant chance of a move as soon as September. Prices including energy and food prices were up just 0.8 per cent on the same month last year.

Minutes from the Fed’s latest rate-setting meeting will be released on Wednesday, and these could affect market odds, as could a speech from Janet Yellen, the Fed chair, who speaks on Friday next week at the central bank’s symposium in Jackson Hole, Wyoming.

Mr Dudley said in his interview that a September rate rise was still on the table, noting the US economy is likely to improve in the second half of the year after a weak showing in the first six months. His comments reversed an early rally in the US Treasury market, sending the 10-year US government bond yield from a low of 1.51 per cent ahead of his remarks to 1.58 per cent soon afterwards.

The interest rate sensitive two-year yield jumped to a three-week high of 0.75 per cent. The stock market was also nudged lower, with the S&P 500 falling 0.3 per cent in early trading on Tuesday.

A September rate increase would contrast with Wall Street expectations: Fed funds futures place just a one-in-five chance that the central bank lifts rates next month, according to Bloomberg calculations based on CME Group data.

Dennis Lockhart, the president of the Atlanta Fed, also signalled that the central bank could move rates in the coming months, saying in a speech that “if my confidence in the economy proves to be justified, I think at least one increase of the policy rate could be appropriate later this year”.

Some Fed policymakers are sufficiently worried about America’s doggedly low inflation numbers to be considering an overhaul to the central bank’s policy framework.

The FT’s one-stop overview of key US economic data and trends, including GDP, inflation, unemployment, consumer indicators, and the outlook for US interest rates

John Williams, president of the Federal Reserve Bank of San Francisco, said on Monday that the current 2 per cent inflation target is not well suited to an economy with a depressed natural interest rate — the rate consistent with an economy operating on an even keel.

“There is simply not enough room for central banks to cut interest rates in response to an economic downturn when both natural rates and inflation are very low,” he said. A higher inflation target “would imply a higher average level of interest rates and thereby give monetary policy more room to manoeuvre”.

The change was one of several that could be considered as officials revamp established approaches to monetary and fiscal policy in order to take into account depressed natural rates of interest, Mr Williams said.

Among the others would be for the central bank to target a given level of prices or nominal output, or for politicians to institute a more active role for budgetary policy in stimulating the economy, for example by automatically varying tax and spending plans in line with the economic cycle.

Additional reporting by Robin Wigglesworth – Financial Times

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