Isn’t That Awkward? The Fed Moves One Way, Inflation Another

Inflation weakens as Fed tightens, making it harder for central bank to keep raising rates

By Justin Lahart

One of the Fed’s aims is to get inflation up to 2%, but the Labor Department reported Wednesday that consumer prices edged lower last month. Photo: Chuck Myers/Zuma Press


Inflation is cooling again, and the Federal Reserve hopes that is only a temporary thing. What if it isn’t?

One of the Fed’s aims is to get inflation up to 2%, a rate that it believes minimizes the risks of the economy overheating or stumbling into recession. So it counted as awkward when the Federal Reserve raised rates on the same day the Labor Department reported that inflation continues to cool.

Consumer prices edged lower last month, the Labor Department reported Wednesday, driven by a decline in gasoline prices. Core prices, which exclude food and energy items to better capture inflation’s trend, came in weak for the third month running, and were up just 1.7% from a year earlier. That implies that the Fed’s preferred measure of core inflation was up just 1.4% on the year, according to J.P. Morgan ’s calculations, which would mark the slimmest gain since late 2015.

The Fed, in announcing its rate increase, indicated a bit more concern about the cool-down, specifying that it is “monitoring inflation developments closely.” Policy makers also lowered their inflation projections for this year.

But the projections also showed policy makers still expect to raise rates once more in 2017.

Additionally, they expect to start shrinking their balance sheet this year, which in effect will make monetary policy tighter.

Part of why inflation is so low is that wage growth, despite the low unemployment rate, has been weak. The Fed is working under the assumption that the tight labor market will eventually flow through into faster wage growth. But as Fed Chairwoman Janet Yellen pointed out in the press conference following the Fed’s meeting, inflation may be less sensitive to unemployment-rate declines than in the past.

There are some one-time changes in prices weighing on inflation—Ms. Yellen noted cellphone service pricing—but the weakness has occurred across enough categories that it is hard to deny that overall inflation has weakened.

Scars consumers still carry from the financial crisis may be playing a role, as might the ease with which technology allows people to ferret out bargains. Whatever the reason, just as the economy remains in a slow-growth rut, inflation might be stuck below 2%.

Investors are betting that is the case. The yield on the 10-year Treasury fell to its lowest level since November and the dollar is at its lowest level versus other major currencies since October.

If so, today’s low inflation readings shouldn’t be read as a sign that deflation risks are elevated, and that the Fed ought to counter them. But at the same time, they call into question why the Fed thinks it is a good idea to keep on raising rates. The economy is cool enough already, and the danger is that the Fed will only make it colder.

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