Fed rattled by elusive inflation, but loath to sound alarm yet

Mon Dec 1, 2014 4:55am EST
 
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By Jonathan Spicer and Ann Saphir

NEW YORK/SAN FRANCISCO (Reuters) - With the U.S. economy humming along at its fastest clip in more than a decade, the Federal Reserve should be confident about its ability to weather a global slowdown and start lifting interest rates around the middle of next year.

But then there is inflation.

Interviews with Fed officials and those familiar with its thinking show the mood inside is more somber than the central bank's reassuring statements and evidence of robust economic health would suggest. The reason is the central bank's failure to nudge price growth up to its 2 percent target and, more importantly, signs that investors and consumers are losing faith it can get there any time soon.

Despite undershooting the goal for three years, the Fed has long succeeded in convincing markets that the target was within reach. However, inflation expectations have begun slipping in recent weeks, threatening to amplify downward momentum from plunging energy prices and stuttering global growth.

Barring a turnaround, Fed officials would hesitate to raise interest rates as soon as mid-2015 even as gradually as their forecasts now suggest. On Friday, prices of short-term interest rate futures showed traders pushed back their expectations for a "lift-off" in rates from near zero until October 2015, later than most Fed officials have signaled so far.

"The primary concern at the moment is whether you can get back to 2 percent in a way that keeps expectations anchored, and maintains the credibility of the Fed as an institution that can achieve its goal," said Jeffrey Fuhrer, the Boston Fed's senior policy advisor.

At first sight, a combination of economic growth of nearly 4 percent, falling unemployment and price increases of around 1.6 percent looks good. Central bankers worry, though, that inflation, instead of picking up further, could head the other way.

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A detail from the front of the United States Federal Reserve Board building is shown in Washington October 28, 2014. REUTERS/Gary Cameron