Food, fuel prices unlikely to shake Fed from path
The Federal Reserve will continue to focus on low underlying inflation in pushing aggressive measures to support the U.S. recovery, even as European authorities fret about rising energy and food prices.
With the U.S. economy only now emerging from a period of inflation so low that policy makers were worried about the risk of a damaging downward spiral of falling prices, the Fed, which opens a two-day meeting on Tuesday, is on a different track than the European Central Bank.
Comments by ECB President Jean-Claude Trichet over the weekend urging central banks to pay attention to inflationary threats from rising commodity prices led many to believe the ECB may be moving toward rate hikes.
Trichet emphasized overall inflation, rather than the core measures favored by the Fed that strip out volatile food and energy costs.
Surging global food prices are a problem more broadly for emerging markets already battling inflationary pressures, and French President Nicolas Sarkozy has made food price spikes a theme the Group of 20 leading rich and emerging economies will tackle this year.
It's not that officials on the Fed don't worry about headline inflation; some of them may even see rising gasoline or wheat prices as warning signs.
But with a sluggish recovery barely chipping away at a U.S. unemployment rate that has remained stubbornly above 9 percent, policy makers will see no reason to tap the brakes until core inflation ticks higher.
While the Fed may identify higher commodity prices as a potential concern, policy makers are not likely to reverse course and tighten policy unless higher commodity prices push through to core inflation, University of Oregon economics professor Tim Duy wrote on his blog. Such an outcome appears unlikely given persistently high unemployment.
FED BIDING ITS TIME
The Fed, which kicks off its first meeting of the Federal Open Market Committee this year with a new roster of voting members under its rotating system, could soften its characterization of underlying inflation to nod to an apparent stabilization after a long period of slowing in its post-meeting statement on Wednesday. But officials are unlikely to raise alarm bells even as food and energy prices mount.
Fed officials have long focused on core price measures because they see those gauges as better predictors of where inflation is heading.
In contrast, the ECB, a newer institution in a region where inflation has had socially disastrous consequences, believes it's important to focus on headline inflation to help keep expectations of future price gains in check.
Purists -- or at least the people in the Fed camp -- would say that monetary policy is most capable of controlling the core components and is less capable of controlling movements in commodity or food prices, said Michael Gapen, a senior U.S. economist at Barclays Capital who was formerly with the Fed.
Trichet is looking at headline euro zone inflation that surged 2.2 percent in the 12 months through December, the first time in more than two years that it topped the ECB's target of below, but close to 2 percent.
The euro has gained more than 1 percent against the U.S. dollar since the start of year, driven by growing expectations that euro zone policy makers will work out a way to deal with the European debt crisis and the belief that price pressures may be moving the ECB closer to tightening its policies.
The UK is also facing inflation pressures. The Bank of England faces credibility problems over holding rates steady in anticipation that inflation -- which leaped 3.7 percent over 12 months in December -- is temporary and will fall back to its 2 percent target, which it has exceeded for more than a year.
U.S. PRICE GAINS MUTED
The Fed does not need to make any such rationalizations at the moment.
The U.S. Consumer Price Index posted its largest monthly gain in 1-1/2 years in December as gasoline prices spiked, but core prices barely budged. The gain in core prices from a year ago was the slowest on records dating back more than 50 years.
A gauge preferred by the Fed because it takes into account changes in consumer behavior, the year-on-year core personal consumption expenditures index, similarly rose a scant 0.8 percent, the slimmest gain since 1960.
Even so, the Fed's activist easing policies, notably its November decision to buy $600 billion in U.S. government debt, have raised concerns about future inflation, even within the U.S. central bank.
The president of the Kansas City Federal Reserve, Thomas Hoenig, who is not a voting member of the FOMC this year, dissented against every Fed policy decision in 2010, arguing for a tighter policy. Philadelphia Fed President Charles Plosser and Dallas Fed chief Richard Fisher, who have moved into voting seats this year, are expected to register their opposition this year, although they may decide to vote with the majority this week.
U.S. inflation expectations, as measured by the difference between inflation-protected securities and nominal securities of the same maturity, have widened recently, which suggests financial markets are growing a bit wary.
However, those spreads had been extremely low before the Fed began discussing further easing measures last summer, and the recent gains appear to reflect a retracement to historically more normal levels. Further, yields on benchmark 30-year and 10-year Treasuries remain at low levels, suggesting the market does not anticipate excessive inflation.
(With additional reporting by Burton Frierson in New York; Editing by Leslie Adler)
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