Chipotle Mexican Grill Inc. (CMG) isn’t charging diners more for guacamole this year, even though the restaurant chain expects to pay more for avocados. That isn’t an appetizing prospect for Federal Reserve policy makers.
Citing “a longer-term general forecast of a stable or perhaps even deflationary food cost,” Chief Financial Officer John Hartung said July 18 that the Denver-based company won’t pass temporary increases in expenses on to customers.
Companies lacking pricing power have helped hold the inflation rate below the Federal Reserve’s 2 percent target for 14 straight months. Chairman Ben S. Bernanke and his colleagues on the Federal Open Market Committee, who meet today and tomorrow, are keeping an eye on receding inflationary pressures as they consider when to start scaling back $85 billion in monthly asset purchases aimed at strengthening economic growth.
Bernanke has said low inflation could cause the recovery to bog down by inhibiting capital investment and increasing the risk of “outright deflation,” a broad-based decline in prices. “Very low inflation poses risks to economic performance,” he told lawmakers July 17. “We will monitor this situation closely.”
Such concerns signal “some renewed focus on where inflation is going” at this week’s meeting, said Michael Hanson, a former Fed economist who is now senior U.S. economist for Bank of America Corp. in New York. Economists and policy makers “don’t see a whole lot of evidence that pricing power’s going to return quickly or that inflation is going to pick up.”
The chairman also said he viewed the slowdown in inflation as reflecting “some factors that are likely to be transitory,” echoing comments he made after the FOMC’s June 18-19 meeting.
Consumer prices rose 1 percent in May from a year earlier, according to an index based on personal consumption expenditures that is the Fed’s preferred inflation gauge. Some policy makers, led by St. Louis Fed President James Bullard, call for sticking with asset purchases, known as quantitative easing, until the economy is strong enough to push inflation closer to the Fed’s goal.
The potential for deflation helped prompt the second round of quantitative easing that started in November 2010. The previous month, Bernanke said in a speech at a Boston Fed conference that there “would appear -- all else being equal -- to be a case for further action,” noting also that “the risk of deflation is higher than desirable.”
Bernanke, a scholar of the Great Depression, addressed the risk almost 11 years ago, at the start of his tenure as a Fed governor. In a speech titled “Deflation: Making Sure ‘It’ Doesn’t Happen Here” that he delivered in Washington in November 2002, Bernanke said monetary policy, including asset purchases, should be used “to stimulate aggregate spending” and prevent deflation.
Declining prices can prompt consumers to postpone purchases in the expectation that goods will keep getting cheaper, while causing companies to delay investment and hold back wage increases. Once a downward price spiral takes hold, it’s difficult for central bankers to reverse it, as Japan’s deflationary trajectory has shown.
When Bernanke delivered his warning, inflation was running at 2.2 percent.
Fed officials in June forecast that prices will rise 1.4 percent to 2 percent next year, according to their central tendency estimates. Their next projections will be released after the Sept. 17-18 meeting.
The central bankers will begin reducing the pace of their $85 billion in monthly asset purchases in September, according to half of the 54 economists in a Bloomberg survey conducted July 18-22. None of the respondents expects the Fed to begin paring its purchases at this week’s meeting.
The FOMC might make changes to the post-meeting statement this week to show an altered inflation perspective, Eric Green, global head of rates, foreign exchange, and commodities research at TD Securities Inc. in New York, said in a July 24 research note.
Policy makers could adjust statement language that currently says low inflation is “partly reflecting transitory influences,” or they might revise language to project that inflation will run “below,” rather than “at or below,” the 2-percent target in the medium term, wrote Green, a former economist at the New York Fed.
“I could imagine certainly people in the room, who are more concerned about inflation, pushing back that this needs to be in the statement more” this week, said Diane Swonk, chief economist for Mesirow Financial Inc. in Chicago, which oversees about $77.6 billion in assets.
When the FOMC does decide the recovery is strong enough to allow tapering asset purchases, it will probably start with a $20 billion reduction in monthly bond buying, with purchases divided between $35 billion in Treasuries and $30 billion in mortgage-backed securities, according to the Bloomberg survey median.
After an initial decision to taper as early as September, the FOMC might hold off further reductions in purchases as long as inflation remains low, Hanson said.
Chipotle’s Hartung said on a July 18 earnings call that the company is holding the line on menu prices even though it paid more for salsa, chicken and cheese during the second quarter and expects beef and avocado prices to rise.
Many of the cost increases are cyclical, deviating from “a tamer food inflation environment generally,” he said.
Chipotle isn’t unique in its reluctance to raise prices. Regional banks reporting on economic activity in the Fed’s most recent Beige Book show that price pressures largely have remained muted. The Beige Book survey, based on anecdotal reports from the 12 Federal Reserve districts, is compiled to help inform the FOMC at its policy meetings.
Retailers in the Kansas City district “did not expect to raise prices over the next three months,” and most restaurants didn’t anticipate menu price increases, even though food costs were expected to rise during the same period, according to the report released July 17. Construction and transportation firms in the region foresaw flat prices, while manufacturers estimated future finished goods would be lower priced.
In the Cleveland district, prices for raw materials and finished goods were flat or lower and steel producers had “limited success” raising prices.
Stable inflation expectations signal reduced risk that deflation could weaken the economy. Consumer prices measured by the personal consumption expenditures index will rise 1.2 percent in the third quarter and 1.4 percent in the fourth, according to a Bloomberg survey of 38 economists conducted July 5 to July 10.
The gap in yields between Treasury Inflation-Protected Securities, or TIPS, and U.S. government debt not indexed for inflation, known as the break-even rate, shows investor expectations for the consumer price index over the next five years were at 1.83 percent on July 26, holding near the 2.1 percent average so far this year.
As the central bankers meet this week, a tweak to statement language or a fresh dissent may reveal a greater focus on inflation. Bullard said he dissented at the June meeting because “the Committee should signal more strongly its willingness to defend its goal of 2 percent inflation” in light of figures showing it was “now well below target,” according to minutes of the meeting.
Those minutes also revealed Bullard isn’t alone on the committee in advocating a more aggressive stance on pricing trends.
“Many others worried about the low level of inflation, and a number indicated that they would be watching closely for signs that the shift down in inflation might persist or that inflation expectations were persistently moving lower,” the minutes said.
Failure to address low inflation could put the U.S. on the path of Japan, where deflation has become “quite difficult to reverse,” Boston Fed Chief Eric Rosengren said in May 16 remarks in Milan. Prices lingering below the Fed’s 2 percent target may mean policy “has not been sufficiently accommodative,” he said.
The FOMC has said the benchmark rate will remain around zero at least as long as inflation over one to two years is forecast at no more than 2.5 percent and unemployment remains above 6.5 percent. The Fed might underscore its readiness to guard against deflation by adding a threshold for inflation on the lower end as well as the upper, said Kevin Cummins, an economist for UBS Securities LLC in Stamford, Connecticut, who formerly worked for the New York Fed.
“I think they’re probably pretty good” chances that the Fed will establish a lower bound for inflation in the next few meetings, Cummins said. If inflation continues to slow, “you could probably assume that it’s going to happen sooner rather than later.”
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