Photographer: Andrew Harrer/Bloomberg

Yellen Ties Rate-Rise Pace to ‘Actual Progress’ on Inflation

  • Fed chair cites persistent shortfall in inflation from target
  • Bar for second rate hike higher than for first, analyst says

Federal Reserve policy makers may need to have more than just confidence that inflation will pick up to raise interest rates again after liftoff.

Chair Janet Yellen on Wednesday suggested that the pace of future rate increases could depend on “actual progress” in price gains toward the central bank’s target. That’s a shift from the requirement the Federal Open Market Committee set for an initial move, to be “reasonably confident” that inflation would move back to its goal over the medium term.

The language adds to reasons to expect that rates will rise gradually after a widely-anticipated liftoff later this month. As measured by the personal consumption expenditures price index, the Fed’s favorite gauge, headline inflation climbed just 0.2 percent in the year through October. So-called core prices, which strip out volatile food and energy costs, rose 1.3 percent.

“Given the persistent shortfall in inflation from our 2 percent objective, the Committee will, of course, carefully monitor actual progress toward our inflation goal as we make decisions over time on the appropriate path for the federal funds rate,” Yellen told the Economic Club of Washington on Wednesday.

Comparing different Fed-preferred inflation measures

While the FOMC is ready to raise rates later this month with “little tangible evidence” of increasing inflation, Yellen indicated that policy makers probably will need more direct proof it’s begun to climb in order to tighten further, said Krishna Guha, vice chairman of Evercore ISI in Washington.

“This means that the bar for the second and subsequent hikes is higher than for the first hike,” Guha said in a note to clients.

Zero Rate

Policy makers reduced their target for the fed funds rate to a range of zero to a quarter percentage point in December 2008 and have held it there ever since. They next meet to map out policy on Dec. 15-16 in Washington.

In her speech, Yellen argued that both overall and core inflation have been temporarily depressed, the former by a sharp fall in energy prices and the latter by a stronger dollar that’s pushed down the costs of imports.

Taking account of those effects, “it appears that the underlying rate of inflation in the United States has been running in the vicinity of 1.5 to 1.75 percent,” she said.

The Fed chief’s language on making progress on inflation and not just employment looks to be a nod in the direction of some of the more dovish members of the FOMC, who have voiced uneasiness about raising rates later this month.

“I admit to some nervousness about our upcoming decision,” Chicago Fed President Charles Evans said in a speech Tuesday in East Lansing, Michigan. “Inflation has been too low for too long.”

Speaking to reporters after the speech, Evans said it will take some time to determine whether inflation is on an upward path toward the Fed’s 2 percent target.

Commodity Prices

“I think that it’s likely that by the middle of next year, we are going to have a better take on the transitory factors that have held down inflation, whether or not commodity prices are going to bounce back or at least stabilize, and things like that,” he said.

Yellen told the Economic Club of Washington she expects the economy to continue to grow at a “moderate pace” over the next several years that will be fast enough to boost both employment and inflation.

While she argued that the labor market has not yet reached full employment, she said the Fed has made more progress in achieving that goal than it has in reaching its inflation objective. The jobless rate in October stood at a seven-year low of 5 percent.

“The health of the labor market is pretty well assured,” said Guy LeBas, managing director at Janney Montgomery Scott LLC in Philadelphia. At the same time, “there is no disputing that we are falling short on inflation.”

That “is really the only criteria that matters” to the pace of rate hikes, he said..

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