Inflation Forecasts Give Fed Room to Trim Purchases: Economy

Economists project inflation is as low as it’s going to get this year. The outlook will help give the Federal Reserve room to reduce its monthly asset purchases in 2013.

Consumer prices will rise 1.2 percent in the third quarter and 1.4 percent in the fourth, based on the personal consumption expenditures index, according to a Bloomberg survey of 38 economists conducted July 5 to July 10. That signals a reduced risk that disinflation could weaken the economy.

Statistics published today support the view that inflation won’t slow further. Prices paid to the nation’s producers climbed 2.5 percent in the year ended in June, the biggest year-over-year increase since March 2012. A pickup in price gains would bring inflation closer to the Fed’s goal of 2 percent, supporting policy makers who want the central bank to start scaling back its $85 billion in monthly asset purchases later this year.

“Expectations are pretty well-anchored close to the Fed’s goal,” said Michael Feroli, chief U.S. economist for JPMorgan Chase & Co. in New York and a former Fed economist. “That gives the Fed some leeway to trim back on purchases.”

Prices in May rose 1 percent from the same month last year, according to the PCE measure, the Fed’s preferred inflation gauge. That was down from a 1.5 percent gain in the year ended in May 2012.

Bullard’s Dissent

The slowing rise in prices prompted St. Louis Fed President James Bullard to dissent at the Federal Open Market Committee’s meeting June 18-19, arguing for a stronger signal of the central bank’s “willingness to defend its inflation goal in light of recent low inflation readings.”

Since 2010, Bullard has expressed concern that slowing inflation could lead to deflation, or a broad decline in prices, and Japanese-style economic stagnation. He has said the FOMC must safeguard the credibility of its inflation target, defending the goal when price gains are either too high or too low.

The FOMC’s June minutes released this week revealed Bullard wasn’t the only one concerned that slumping inflation might sap the economic recovery.

“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.

Bernanke Rally

Hours after the minutes were published, Fed Chairman Ben S. Bernanke called for maintaining “highly accommodative monetary policy,” setting off a rally in Treasuries and pushing stock indexes to record highs.

Treasuries fell in today’s trading, pushing the yield on the 10-year note up 1 basis point to 2.58 percent as of 4:33 p.m. in New York. The cost of insuring U.S. government debt from losses for five years with credit-default swaps fell 2 basis points this week to 26 basis points, the lowest since October 2009. Stocks rose, with the Standard & Poor’s 500 Index gaining 0.3 percent to 1680.19.

Today’s report on producer prices showed a 0.8 percent increase in June from the prior month, more than projected and the most since September.

Some companies are already marking up retail prices in anticipation of higher raw materials costs. La-Z-Boy Inc. of Monroe, Michigan, raised prices effective May 1 because it expects to pay $11 million to $13 million more for materials in 2014, Chief Financial Officer Louis Riccio said on a June 19 conference call.

Consumers surveyed in July expect an inflation rate of 3.3 percent over the next 12 months, up from the June projection of 3 percent, according to the Thomson Reuters/University of Michigan survey of consumer sentiment published today.

Inflation Expectations

The FOMC said in its June 19 statement that the recent slowdown in inflation was “partly reflecting transitory influences,” and that “longer term inflation expectations have remained stable.”

A plurality of economists in a June 19-20 Bloomberg survey said the central bank will reduce the pace of its asset purchases at the FOMC’s Sept. 17-18 meeting.

“You really want to make this announcement into strengthening data and turning inflation -- you don’t want to make this announcement when the economy is slowing down and inflation is grinding to a low,” said Julia Coronado, chief economist for North America at BNP Paribas SA in New York, and a former Fed economist.

Coronado, who sees inflation at 1.1 percent by year-end compared with the 1.4 percent median in the survey for the fourth quarter, said the economic data probably won’t be strong enough to persuade policy makers to begin reducing the purchases until December.

Growth Estimates

The Bloomberg survey also showed that economists’ estimates of gross domestic product were little changed for this year, and unchanged for 2014 and 2015. The economy expanded at a 1.6 percent annualized rate in the second quarter, according to the median of 68 responses. That’s down from a median of 1.7 percent in the previous survey.

The economists still project the world’s largest economy will grow at a 2.3 percent pace in the third quarter and 2.6 percent in the fourth.

The growth projections follow a forecast this week from the International Monetary Fund, which said world economic growth will struggle to accelerate this year as a U.S. expansion weakens, China’s economy levels off and Europe’s recession deepens. Global growth will be 3.1 percent this year, unchanged from the 2012 rate, and less than the 3.3 percent forecast in April, the Washington-based fund said as it trimmed its prediction for this year a fifth consecutive time.

Pent-Up Demand

Pent-up demand, including in the housing market and automobile industry, may help boost growth in the U.S. economy beyond 2013, said Ryan Sweet, a senior economist at Moody’s Analytics Inc. in West Chester, Pennsylvania.

“Unlike this year, where it’s trickling out into certain segments of the economy, I think next year we’ll start to see more pent-up demand being released, and that’s what’s going to take an economy that’s growing below its potential to back above it,” Sweet said. “I think that’s really going to be what propels us above potential GDP growth and really starts to help bring down the unemployment rate.”

The jobless rate is projected to fall to 7.5 percent in the third quarter and 7.3 percent at year-end from its current rate of 7.6 percent, according to another Bloomberg survey released yesterday. The median estimate of 65 economists shows the rate will fall to 7 percent sometime next year, in line with the Fed’s projections.

Bernanke said June 19 that “when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7 percent,” which would probably happen around mid-2014.

Good Inflation

Jeffrey Mezger, president and chief executive officer of Los Angeles-based homebuilder KB Home, is among those who, like Bullard, view a little inflation as a good thing.

Mezger referred to recent increases in mortgage rates on a June 27 conference call. The average rate on a 30-year fixed mortgage was 4.51 percent in the week ended July 11, the highest in almost two years, according to data from Freddie Mac. The rate fell to 3.31 percent in November, the lowest in records dating to 1972.

“If rates go up, it’s because price inflation is occurring, and inflation is occurring because there’s job growth,” Mezger said. “And if there’s job growth, there’s a better economy.”