Is It Time to Push Back Against Coming Inflation?

June 30, 2017

Fixed income sovereign debt yields have been rising. The Federal Reserve has already raised the federal funds rate four times and is promising more increases as well as separate actions to begin trimming its $4.5 trillion balance sheet. ECB President drew attention after observing that forces of reflation are displacing forces of deflation, and a third of the Bank of England’s Monetary Policy Committee wanted to hike their interest rate at their last meeting.

Nobody’s yet hollering inflation in the crowded theater. The starting points for a turn in the direction of monetary policy is so stimulative that an interest rate hike here and another gradual hike there still leaves policy in an accommodative framework. But make no mistake, policy is tighter after each action that withdraws a piece of stimulus than it was before, and often the change in monetary conditions exceeds the simple 25-basis point size of the central bank interest rate hike. When monetary officials raise rates, it affects currency relationships, long-term interest rates, other financial market variables and inflation expectations in ways that can augment what the central bank has done.

So it’s important as central banks normalize their stances that they act in response to evolving data and not merely according to a sense that enough time has passed since the last action. Lately, that hasn’t been all that apparent. Lately, it has seen that monetary officials are motivated more by an urgency to be prepared with room to ease when the next economic downturn comes than a fear of being asleep at the switch and allowing an inflationary environment to take hold.

Just today, inflation reported from Japan, Euroland and the United States each failed to support the contention that inflation is rising.

  • Japanese core consumer prices failed to rise in month-over-month terms for a fourth straight time in May. Tokyo consumer prices, both the total all-items index and the CPI excluding fresh food and energy, fell 0.2% at an annualized rate between December and June, that is during the first half of 2016.
  • In the euro area, total CPI inflation in June was 1.3%, down from 1.9% in April. Core inflation was 1.1% versus 1.2% in April and 0.9% a year earlier.
  • The U.S. personal consumption price deflator dipped 0.1% in May, and its 12-month rate of increase was 1.4%, down from 1.7% in April, 1.8% in March and 2.1% in February. The core PCE price index edged up 0.1% on month and also climbed just 0.1% between February and May. The on-year rise in the core PCE price deflator of 1.4% in May was down from 1.8% in the first two months of 2017.

All this is not to say that officials are wrong to nudge macroeconomic policy closer to neutral, assuming they can get away with doing that without unduly stressing the economy. Fed officials are prudent to expedite normalization before the next U.S. recession. The current business cycle upswing isn’t young, having just completed its eighth year. The Republican federal government believes that a combination of financial market deregulation and broad tax reform (meaning cuts) are just what the country needs to stretch the upswing considerably further. However, that’s the very policy combination that led up to the Great Recession. This time, protectionist trade policy may create another downside risk. The operative word for central bankers needs to be gradual and seeking guidance from the data.

Copyright 2017, Larry Greenberg. All rights reserved. No secondary distribution without express permission.



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