Pressure builds on Fed over inflation

Market Beat

Oil at $112.79 a barrel, up 23% this year. Silver at $40.60 an ounce, up 31%. Corn at $7.68 a bushel, up 22%.

Are these disturbing numbers? The European Central Bank thinks so. Citing the need to battle inflation, ECB policymakers raised their key short-term interest rate Thursday for the first time since mid-2008 (not incidentally, the last time commodity prices were going wacko).

It wasn’t much of an increase — from 1% to 1.25% — but it made the point: The ECB worries that money has been kept too easy for too long.


The bank’s decision heightens the debate over the Federal Reserve’s official stance, which is that inflation isn’t yet a serious threat in the U.S. and that monetary policy should stay loose to keep the economic recovery on track.

The latest jump in commodity prices will put the Fed further on the defensive. So might the eroding dollar, which slumped this week against a host of other currencies.

The Fed not only is steadfastly holding its benchmark short-term interest rate near zero, but since November it has been committed to buying $600 billion of Treasury bonds through June in an effort to hold down longer-term rates.

Fed Chairman Ben S. Bernanke has become odd man out among the world’s central bankers, many of whom have been tightening credit over the last year as energy and food prices have surged. The People’s Bank of China on Tuesday raised interest rates for the fourth time since October.

Bernanke this week called inflation pressures “transitory.” But the commodity markets seem to be mocking him. U.S. crude oil prices, at just under $113 a barrel Friday, were up 4.5% for the week to the highest point since September 2008 amid ongoing fears about the turmoil in the Middle East and North Africa.

If this is transitory, the man on the street no doubt would like to know when the transition to lower prices at the gas pump will begin.


Bernanke’s views have held sway over Fed policy, but he increasingly has been challenged by some of his peers at the central bank who think the time has come to pull back on monetary stimulus for the economy.

“Having done our job, I see many risks to the Fed overstaying its welcome,” Richard Fisher, president of the Fed’s Dallas branch, said in a speech Friday.

Bernanke has stressed that Congress gave the Fed two mandates. One is to keep inflation under control and the other is to boost employment. With the U.S. jobless rate at 8.8%, the central bank’s work on the employment front isn’t done, the Fed chief has said repeatedly.

The ECB, by contrast, has only one mandate: suppress inflation, which in the euro zone countries was up 2.6% in March from a year earlier, significantly above the ECB’s target of about 2%.

Many economists side with Bernanke on the idea of holding off from credit-tightening moves. Carl Weinberg, founder of High Frequency Economics in Valhalla, N.Y., contends that it’s ECB President Jean-Claude Trichet who is wrong-headed on policy, not Bernanke.

Raising interest rates to try to beat back food and energy prices is ludicrous, Weinberg said. People have to eat and they have to use energy, and they typically don’t borrow money to do either.


All the ECB accomplishes with higher rates is to “worsen growth prospects in the euro zone and worsen the outlook for the banking system,” Weinberg said. By raising rates, the ECB forces European banks to pay more for money at a time when many still are repairing their balance sheets from the 2008 financial-system meltdown.

What’s more, higher inflation can’t take root unless it spreads to wages, and in the U.S. the glut of labor ensures that we’re a long way off from rapid wage inflation, Weinberg said.

That makes rising food and energy costs potentially deflationary for the rest of the economy rather than inflationary, he said: The more you spend to eat and drive, the less you have to spend elsewhere.

Fed critics, however, insist that by keeping short-term interest rates near zero and by flooding the financial system with more money via Treasury-bond purchases, the Fed risks stoking inflationary fires that could be difficult to snuff out.

Other central banks have complained that easy money in the U.S. is feeding speculation in commodities such as oil, grains and metals. Bernanke denies that, yet at the same time he credits Fed policy with helping to lift stock prices since August.

How could stocks benefit from cheap money, but not commodities? “You can’t have it both ways,” said Joe LaVorgna, chief U.S. economist at Deutsche Bank Securities in New York.


Fed policy also has been aimed at weakening the dollar as a way to help U.S. exporters, by making their goods less expensive for foreign buyers.

What the Fed doesn’t want, however, is a sudden downward spiral in the dollar. Even before the dollar fell Friday ahead of the threatened U.S. government shutdown, it was in a broad retreat this week that had the doomsday crowd on the Internet buzzing about a “dollar crisis.” The buck fell 1.7% against the euro, 2% against the Australian dollar and 2.4% against the Brazilian real.

A falling dollar threatens to boost U.S. inflation by raising the cost of imported goods.

Yet if the Fed wants to be comforted, it can simply look to the bond and stock markets. They aren’t signaling much concern despite commodities’ latest ascent and the dollar’s descent.

Treasury bond yields have risen in recent weeks, but they’re still below their levels of early February. As for stocks, key U.S. indexes hit multiyear highs at midweek then eased modestly on Thursday and Friday. The Dow Jones industrial average ended the week at 12,380.05 and is up 6.9% year to date.

Bernanke, however, has told the American people that he’s answerable to them. And the risk he faces is that the people increasingly think the country is headed for an inflation problem well beyond the official 2.1% gain in the consumer price index in the 12 months ended in February.

The inflation rate Americans expect over the next 12 months surged to 6.7%, on average, in the Conference Board’s March consumer confidence survey. The figure was the third straight increase and was up sharply from 5.6% in the board’s February survey.


A 6.7% inflation rate seems a stretch, but the trend is more important than the numbers: Bernanke can’t afford for the public to believe that the Fed will allow inflation to escalate.

In the statement after its March 15 meeting, the Fed said that “long-term inflation expectations have remained stable.”

It should be getting harder for policymakers to say that with a straight face.