Pressure Growing For Fed To Raise Rates
There is a growing pressure from some members of Federal Reserve Board to raise rates with the mounting threat of inflation due to high dollar denominated commodity prices, namely food and oil. Fed Chairman Ben Bernanke has thus far resisted these efforts believing that the economic slowdown will help slow inflation growth.
Inflation has remained high, largely reflecting sharp increases in the prices of globally traded commodities. Thus far, the pass-through of high raw materials costs to the prices of most other products and to domestic labor costs has been limited, in part because of softening domestic demand. However, the continuation of this pattern is not guaranteed and future developments in this regard will bear close attention.
Moreover, the latest round of increases in energy prices has added to the upside risks to inflation and inflation expectations. The Federal Open Market Committee will strongly resist an erosion of longer-term inflation expectations, as an unanchoring of those expectations would be destabilizing for growth as well as for inflation.
Thus far the numbers appear to confirm this with core inflation excluding food and energy rising slowly, however in April the Producer Price Index for finished goods showed an increase that was higher than what many economist were predicting. Energy and food prices actually retreated somewhat that month before climbing again in May and June.
The Fed is in a difficult position, while inflation pressure continues to increase, unemployment has started to creep up. There also remains quite a bit of instability in financial markets with more writedowns expected from the subprime fallout.
With inflation starting to become a concern in other economies of the world, a number of central banks are considering rate hikes themselves, which would put negative pressure on the dollar and raise commodity prices further. As much as the Fed would like to keep rates at their current level until the housing market shows signs of improvement, many investors believe that the Fed will have to act soon, with futures trading pricing in a rate hike by September.
