Fed on Hold as U.S. Consumer Prices Show No Threat of Inflation

Fed on Hold as U.S. Consumer Prices Show No Threat of Inflation

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By Timothy R. Homan

Oct. 15 (Bloomberg) -- Slowing inflation may give the upper hand to Federal Reserve policy makers who want to keep interest rates low for a long time to support a recovery from the worst recession since the 1930s.

The consumer-price index rose 0.2 percent last month, after a 0.4 percent increase in August, figures from the Labor Department showed today in Washington. Compared with a year earlier, consumer prices were down 1.3 percent.

Recent comments have shown a growing rift between policy makers who believe the central bank has plenty of time to act before inflation flares and those saying rate increases may happen sooner, or with more force, than some investors anticipate. Bond-market trading shows investors expect inflation over the next 10 years to exceed the latest readings.

The Fed “can keep it low for quite some time,” said Steven Ricchiuto, chief economist at Mizuho Securities USA Inc. in New York, referring to the benchmark rate. “There’s a lot of excess slack built into the system, and it’s not going to go away quickly.”

Ricchiuto forecasts central bankers won’t raise rates at least through the middle of 2011. The median estimate of economists surveyed by Bloomberg News from Oct. 1 to Oct. 8 showed policy makers will wait until the third quarter of 2010 to start raising that target for the overnight borrowing cost between banks as unemployment rises and inflation slows.

The rate has been near zero since December, the lowest on record.

Fed Minutes

The minutes of the policy-making Federal Open Market Committee’s Sept. 22-23 meeting, released yesterday, showed officials weighed the risks that an anemic recovery would lead to “subdued and potentially declining wage and price inflation.”

Fed Vice Chairman Donald Kohn, echoing the concerns of New York Fed President William Dudley, said this week that inflation and growth will probably stay below the Fed’s objectives for some time, warranting low interest rates for an “extended period.” In contrast, Kansas City Fed President Thomas Hoenig and Fed Governor Kevin Warsh have been among those saying rate increases may be needed sooner.

Today’s report on consumer prices showed the so-called core index, which excludes food and energy, climbed 0.2 percent in September, pushed up by health-care and a rebound in automobile prices. Compared with September 2008, prices climbed 1.5 percent after a 1.4 percent increase in the 12 months ended in August.

Inflation Outlook

The difference between rates on 10-year notes and TIPS, which reflects the outlook among traders for consumer prices, was at 1.97 percentage points today, the most in more than two months. The spread, which signals the expected inflation rate over the next 10 years, is little changed from the 2.18 percentage points average over the last five years.

Categories such as rents and food are among those making a pickup in inflation less likely, economists said. Rents, which account for almost 40 percent of the core index, dropped 0.1 percent last month, the fist decrease since 1992. Record levels of vacancies will probably continue to restrain those costs.

Food prices were down 0.2 percent in the 12 months to September, the first year-over-year drop since 1967.

To contact the reporter on this story: Timothy R. Homan in Washington at thoman1@bloomberg.net