Fed to stick with low rates, despite oil price rise

Two of the Federal Reserve's most powerful officials said on Monday the U.S. central bank should stick to its super-easy monetary policy, arguing inflation is not a threat and unemployment remains too high.

Underlying U.S. inflation trends are subdued and long-term price expectations are contained, despite rising commodity costs, Janet Yellen, the Fed's influential Vice Chair, told the Economic Club of New York.

She argued the recent run-up in energy prices was more of a damper on consumer spending than an inflation risk, saying broad-based price increases are unlikely without substantial gains in wages, which have been largely stagnant.

I anticipate that recent increases in commodity prices are likely to have only transitory effects on headline inflation, said Yellen, echoing remarks from Fed Chairman Ben Bernanke last week.

This accommodative policy stance is still appropriate because unemployment remains elevated, longer-run inflation expectations remain well anchored, and measures of underlying inflation are somewhat low, Yellen said.

New York Fed President William Dudley struck a similar note, saying the Fed shouldn't be too enthusiastic about tightening monetary policy soon because the economy continues to operate well below its full potential.

Oil prices could push up headline inflation, Dudley said, but central bankers shouldn't overreact as the rise is likely to be temporary and could lead to a monetary policy mistake, he said in Tokyo. U.S. crude prices fell on Tuesday but remained near $110 a barrel.

If inflation expectations became unanchored, the Fed would have to respond. I don't see any signs that expectations are becoming unanchored, Dudley said.

Their comments, which echo remarks by Fed Chairman Ben Bernanke last week, suggest the Fed is committed to completing its $600 billion bond-buying stimulus program as scheduled, and that growing market chatter about possible policy tightening may be premature.

The European Central Bank by contrast last week raised rates for the first time since the end of the recession and hinted at the possibility of more. Many emerging economies, including China, have also been attempting to tighten lending conditions, fearing years of rapid growth may be turning inflationary.

NO V-SHAPE IN SIGHT

Fed policymakers are trying to distinguish between increases in highly visible prices like food and gasoline and a broader, more entrenched trend of cost rises that would warrant higher interest rates.

A number of more hawkish presidents of regional Fed banks have begun to argue that rate hikes might be needed before the end of the year.

Yellen's remarks, however, emphasized a number of lingering weaknesses in the economy, including a battered construction sector.

A sharp rebound in economic activity -- like those that often follow deep recessions -- does not appear to be in the offing, Yellen said.

She argued that there was reason to be skeptical of the sharp recent decline in the jobless rate to 8.8 percent in March from 9.8 percent in November.

The decline that we've seen partly reflects a drop in labor force participation, she said. While the labor market has recently shown some signs of life, job opportunities are still relatively scarce.

Yellen dismissed the notion that structural factors beyond the reach of monetary policy accounted for a very large proportion of the rise in joblessness during the recession.

She said markets had already priced in the end of Fed bond purchases in June, and should take the end of the policy in stride.

In a research paper published on Monday, Chicago Fed President Charles Evans also argued commodity price gains should not be mistaken for a harbinger of inflation.

If commodity and energy prices were to lead to a general expectation of a broader increase in inflation, more substantial policy rate increases would be justified, Evans said in the paper, which was co-authored by Chicago Fed researcher Jonas Fisher. But assuming there is a generally high degree of central-bank credibility, there is no reason for such expectations to develop.