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Fed overstates impact of dollar, oil on inflation, Goldman says
[NEW YORK] US inflation, which the Federal Reserve has tied to its decision of when to raise interest rates, is being restrained more by labor market slack than the transitory influences of a stronger dollar and lower oil prices, Goldman Sachs Group Inc economists said.
A Fed computer simulation of the US economy, used by officials to gauge fallout from the dollar and energy prices, significantly overstated the drag they exert on core inflation, according to a Goldman Sachs report published Wednesday.
That runs counter to the message from Fed Vice Chairman Stanley Fischer, who said in a Saturday speech in Jackson Hole, Wyoming, that "the rise in the dollar since last summer, of about 17 per cent in nominal terms, with its associated declines in non-oil import prices, could plausibly be holding down core inflation quite noticeably this year."
Policy makers' assessment of the outlook for inflation is vital to the timing of rate liftoff. That judgment may hinge on how much importance they place on the role of transitory influences in keeping price pressures too low, versus the more stubborn drag of labor market slack. Officials next meet Sept 16-17.
The Fed's preferred measure of inflation, the price index of personal consumption expenditures, rose 0.3 per cent from a year earlier in July and has been below the Fed's 2 per cent target for three years. The core measure, which strips out prices of food and energy and is commonly described by officials as the best predictor of where headline inflation is going, showed a 1.2 per cent annual inflation rate in July.
The computer model Fischer cited in his speech may be overestimating the effects of transitory influences of the dollar and oil on inflation by as much as eight times, Goldman economists Zach Pandl and Sven Jari Stehn wrote in their note to clients. Core goods prices fell 0.8 per cent in the year through July, and their weight in the index implies only 0.1 or 0.2 per centage point of drag from the dollar, they said.
Minutes of the Fed's July 28-29 policy meeting showed growing uncertainty over whether inflation would rise back to the 2 per cent target in a timely manner.
"Transitory factors such as the strong dollar and falling commodities have probably depressed domestic consumer prices to a degree, but we doubt they explain most of the shortfall of core PCE inflation relative to the Fed's target," Pandl and Stehn wrote. "Instead, we see room for other factors - such as continued slack in the labor market - which may have more lasting effects."
Investors saw a 30 per cent probability the Fed will raise rates next month, according to trading in federal funds futures at 11:55 am in New York on Thursday, and a 41 per cent chance of a move by October. The chances for a rate increase by December were 56 per cent.