Fed, ECB, BOE Officials All Say They See Inflation Rising

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Stanley Fischer
Federal Reserve Vice Chairman Stanley Fischer at the Jackson Hole economic symposium on Aug. 28. Photographer: David Paul Morris/Bloomberg

Stronger growth will pull inflation higher in the U.S. and Europe, according to three top central bankers who voiced confidence that their regions will escape from headwinds that are keeping inflation too low.

Federal Reserve Vice Chairman Stanley Fischer joined European Central Bank Vice President Vitor Constancio and Bank of England Governor Mark Carney Saturday on a panel at the Kansas City Fed’s annual retreat in Jackson Hole, Wyoming, dedicated to discussing inflation dynamics. Their optimism has not been shared up until now by investors, trading in inflation-protected bonds shows.

“Given the apparent stability of inflation expectations, there is good reason to believe that inflation will move higher as the forces holding down inflation dissipate further,” Fischer said in his prepared remarks.

“With inflation low, we can probably remove accommodation at a gradual pace,” Fischer said. “Yet, because monetary policy influences real activity with a substantial lag, we should not wait until inflation is back to 2 percent to begin tightening.”

While Fischer has left open the option of an interest-rate increase when policy makers meet next month, he didn’t express a preference for acting that soon.

“I do not plan to upset your rational expectation that I cannot tell you what decision the Fed will reach by Sept. 17,” he told the symposium Saturday.

Future Inflation

Price increases in the U.S. and Europe have been running well below levels targeted by the central banks, where officials are debating what slower Chinese growth and weaker commodity prices could mean for future inflation.

While U.S. officials are weighing the timing of their first interest-rate increase since 2006, and the Bank of England may tighten in early 2016, the ECB has heard calls to extend its quantitative easing program to provide more protection against potential deflation.

“The link between inflation and real activity appears to have strengthened in the euro area recently,” the ECB’s Constancio said in a paper delivered at Jackson Hole. “Provided our policies are able to significantly reduce the output gap, we can rely on a material effect to help bring the inflation rate closer to target.”

Market Expectations

Investors may not share this optimism. Five-year, five-year inflation swaps in the euro area -- which reflect expectations for the five-year path of inflation five years from now -- show that market-based inflation expectations slid to about 1.65 percent in August from about 1.85 percent at the beginning of the month. That’s almost as low as when the ECB started its quantitative easing program in March.

In the U.S., the five-year, five-year forward breakeven rate, 2.16 percent at the beginning of August, slid as low as 1.89 percent on Aug. 24.

Such movements show that “we should however be cautious in our assessment that inflation expectations are remaining stable,” Fischer said. Still, “these movements can be hard to interpret, as at times they may reflect factors other than inflation expectations.”

Fed Chair Janet Yellen and ECB President Mario Draghi both skipped the Jackson Hole event this year. The ECB Governing Council meets in Frankfurt on Sept. 3 while the Fed’s policy-setting committee gathers on Sept. 16-17. Both banks are short of their 2 percent inflation targets. Euro-zone inflation was 0.2 percent in July, while the price gauge favored by the Fed rose 0.3 percent in the 12 months through July.

U.K. Momentum

In the U.K., Bank of England Governor Mark Carney said “the prospect of sustained momentum” in the economy and a gradual pickup in inflationary pressures “will likely put the decision as to when to start the process of gradual monetary policy normalization into sharper relief around the turn of this year.”

He said “recent events” including China’s slowdown so far don’t call for changing the BOE’s strategy for returning inflation to target. U.K. headline inflation was just 0.1 percent in July, well below the bank’s 2 percent goal.

While the world’s major central banks are focused on bringing inflation up, the lack of price pressure isn’t a universal problem, said Raghuram Rajan, governor of the Reserve Bank of India.

“Unlike our other panelists, I have the problem of dealing with the traditional central banker problem of high inflation and the task of bringing it down,” he said. “We’re disinflating in a world of very low global inflation and that has problems.”