By Craig Torres March 16 (Bloomberg) — Douglass Henry, chief executive officer of Henry Molded Products in Lebanon, Pennsylvania, used to worry about inflation because a jump in energy prices could drive up production costs. Now, with prices “pretty darn flat,” he’s also concerned about the risk the inflation rate will fall too low. Profit margins at his company, which employs 102 people to make packaging materials for products used in printers made by Hewlett-Packard Co. and Dell Inc., might be undermined as competitors cut prices. “They still have excess capacity,” Henry, a former chairman of the Federal Reserve Bank of Philadelphia’s business council, says of his rivals. “When a piece of business comes up, they have a tendency to make a reach for new volume and they will depress prices.” Prices may move to the center of the debate over the timing of an exit from the most stimulative U.S. monetary policy in history. Low inflation will keep the benchmark interest rate unchanged until the middle of 2011, predicts former Fed governor Laurence Meyer . Policy makers meet today, and the Federal Open Market Committee will release its statement around 2:15 p.m. New York time. The Fed’s preferred price gauge will slow to a gain of 1.2 percent this year, the lowest since 1962, according to a Bloomberg News survey of economists this month. Economists also forecast the Fed will raise rates by a half point to 0.75 percent in the fourth quarter, and unemployment will end the year at 9.5 percent, the survey shows. Doesn’t Hold Up Meyer, vice chairman of St. Louis-based Macroeconomic Advisers LLC, says the outlook for a rate increase doesn’t hold up to scrutiny. “If you think the unemployment rate is going to be above 9 percent and inflation around 1 percent at the end of this year, I don’t think you should have any expectation” of a rate increase by the end of 2010, he says. Meyer’s firm predicts the Fed’s preferred price gauge, the personal consumption expenditures price index, minus food and energy, will rise 0.9 percent this year and next, with economic growth of 3.5 percent and 3.8 percent. If the Fed stays on hold while some reports show the recovery gaining traction, yields on long-term Treasury securities will rise faster than those for short-term notes, says Anshul Pradhan, an analyst at Barclays Capital in New York. The yield difference between two-year and 10-year U.S. government securities was 2.76 percentage points yesterday, compared with 1.95 percentage points a year ago. Inflation Expectations Chairman Ben S. Bernanke has repeatedly discussed the need to reverse a record expansion of the Fed’s balance sheet to avoid inflation once the economy picks up. The timing depends on officials’ estimates of how long low inflation will persist and whether inflation expectations break lower or higher. Total excess reserves in the banking system stand at $1.2 trillion. “There is a cadre of members at the Federal Reserve that are absolutely convinced that core inflation will be quiet,” says Allen Sinai , president of Decision Economics Inc. in New York. “At the moment, that looks more right than wrong.” Sinai includes in that group regional Fed presidents Janet Yellen in San Francisco, William Dudley in New York, Charles Evans in Chicago, and Eric Rosengren in Boston as well as Bernanke and Vice Chairman Donald Kohn . Yellen is President Barack Obama’s choice to replace Kohn, who retires in June, three people with knowledge of the selection process said last week. ‘Unwelcome’ Decline U.S. central bankers warned of an “unwelcome substantial fall in inflation” in 2003, and kept their policy rate at 1 percent for the year. Deflation can be harmful to businesses whose fixed costs on debt and salaries decline more slowly than the prices they charge for the goods and services they sell, squeezing profits. “For all of the imperative to step away from unconventional policy and the constant discussions on exit strategy, what do we do if these persistent declines on core inflation continue?” says Mark Spindel , chief investment officer at Potomac River Capital LLC, a Washington-based hedge fund that specializes in inflation-related strategies. High unemployment and idle capacity haven’t lowered inflation expectations. Consumer predictions for inflation in a year’s time have ranged from 2.5 percent to 2.9 percent over the past six months, according to a Reuters/University of Michigan survey. “The Fed wants to have inflation expectations maintained because it is one of the lines of defense against deflation,” says Ethan Harris , head of North America economics at Bank of America-Merrill Lynch Global Research in New York. Not all FOMC members are willing to keep the benchmark lending rate near zero for several more months. ‘No Longer Warranted’ Kansas City Fed chief Thomas Hoenig in January dissented against the pledge to keep rates low for an “extended period,” saying it was “no longer warranted.” Philadelphia Fed President Charles Plosser last month said the phrase has “gotten us in a box.” Morgan Stanley economists Richard Berner and David Greenlaw predict an inflation rebound and forecast the federal funds rate, the target for overnight lending among banks, will rise to 1.5 percent by the end of the year. “A strong global recovery will lift commodity prices and inflation expectations,” says Berner, co-head of global economics. “That lift, coupled with narrowing slack in the economy and labor markets, will begin to reverse the inflation downtrend by the summer.” Inflation Forecasts While Fed officials discuss the risk of inflation in speeches, the concern isn’t reflected in their forecasts. They predict core and headline inflation in a range of 1 percent to 2 percent for the next three years, according to so-called central tendency forecasts made in January. “With the unemployment rate at 9.7 percent and inflation significantly under my benchmark for price stability, there is no conflict between our policy goals,” of low and stable inflation and full employment, Chicago Fed president Charles Evans said in Arlington, Virginia, March 9. At Henry Molded Products, lower prices on motors and pipe have allowed Henry to boost efficiency at his molded paper mill, and high unemployment means he doesn’t have to bid up wages to find labor. Still, few businesses want to see prices collapse. “Inflation is very, very low,” Home Depot Inc. chief financial officer Carol Tome said on a Feb. 23 conference call with analysts. “We aren’t seeing any pricing pressure.” To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net
See the article here:
Fed Officials May Set Sights on Avoiding Low U.S. Inflation in Exit Debate
