While slightly improved, inflation remains below the Fed's target. What does that mean for interest rates?
U.S. consumer prices rebounded slightly from last month’s precipitous drop-off, while prices were flat over the past 12 months.
The Consumer Price Index increased 0.2% last month as oil stopped its dramatic fall, and was unchanged compared to this time last year, according the the Labor Department. So-called core inflation, which strips out volatile energy and food prices, rose by 1.7%, still well below the Federal Reserve’s 2% target.
Prices had fallen the three previous months.
While firmer than previous months, these low inflation rates come at a critical time for the Federal Reserve.
Investors have received mixed messages from central bank officials and economic data recently. For months, the Fed had reassured Wall Street that it would be patient when it comes to removing its accommodative monetary policy. Last week, though, the Fed dropped the word “patient” from its statement, implying that interest rates could rise soon—perhaps as early as June.
Yet in the same breath, the Fed lowered its growth and inflation expectations in the near term and signaled that even if rates are lifted soon, they won’t climb as rapidly as previously thought. That caused the stock market to soar.
“Just because we removed the word ‘patient’ from the statement doesn’t mean we are going to be impatient,” Yellen said in a press conference after the statement was released. “Moreover, even after the initial increase in the target funds rate, our policy is likely to remain highly accommodative to support continued progress toward our objectives of maximum employment and 2% inflation.”
Fed Vice Chair Stanley Fischer said yesterday that rates would likely rise this year. The federal funds rate, Fischer said, will be determined by economic conditions, rather than by a predictable path.
Competing economic indicators and measurements are complicating the Fed’s dual-mandate of price stability and maximum employment. Employers hired nearly 300,000 workers last month, and the unemployment rate dipped to a post-recession low of 5.5%.
Yet wages aren’t growing strongly and the strong dollar, while a boon for U.S. tourists traveling abroad, has made U.S. exporters less competitive globally. Low oil prices save hundreds, if not thousands, of dollars for drivers annually, but have weighed heavily on the bottom line of energy companies.
The Fed seems to be inclined to raise rates given the improving labor market, but has been hamstrung by a lack of meaningful inflation and consistent wage acceleration. By increasing the cost of borrowing, the Fed runs the risk of slowing down economic activity in the midst of a burgeoning recovery. Will interest rates really rise before economists can see the whites of inflation’s eyes?