Central Bankers Rethink Views on Inflation

29 Aug 2015 | Author: | No comments yet »

Central Bankers Rethink Views on Inflation.

LONDON: The dollar eased against a basket of major currencies for the first time in four days on Friday, with investors awaiting fresh comment from the US Federal Reserve on interest rates after a tumultuous week in global financial markets.The dollar had bounced back from seven-month lows struck on Monday as a semblance of calm returned to markets, with the greenback also benefiting from upbeat US data.The dollar index was down 0.1 percent at 95.514, off a one-week high of 96.031 set on Thursday.

in Jackson Hole and in Washington A senior United States Federal Reserve official yesterday left the door open for a rate rise as soon as September, even as market turbulence cast a cloud over the outlook for US monetary policy.The dollar finished Friday’s session with weekly gains against the euro and the pound as U.S. stocks stabilized and a spate of strong U.S. economic data helped assuage investors’ fears of sustained market turmoil.The topic at the Federal Reserve Bank of Kansas City’s annual economic symposium in Jackson Hole, Wyo., is “Inflation Dynamics and Monetary Policy.” Pardon the attendees at this year’s meeting, which runs through Saturday, if they are feeling a little deflated. Still, after diving to a seven-month trough of 92.621 on Monday when global stock markets went into a tailspin, the index has bounced more than 3 percent.Against the yen, the greenback dipped below 121 yen, still a remarkable recovery from Monday’s seven-month low of 116.15.

Minutes from a meeting of Federal Reserve policy makers released on Aug. 19 kicked off a period of weakness in the dollar, as investors pushed back their expectations for the timing of the first Federal Reserve interest-rate increase since 2006. Some analysts have argued a U.S. central bank rate hike would cause a deflation scare in the domestic economy as a stronger dollar would cause commodity prices to fall.

Mr Fischer’s comments highlight just how China’s August 11th devaluation and the market volatility it set off have complicated the Fed’s plans for a September rate increase. The minutes showed policy makers were second-guessing whether an interest-rate hike in September would be appropriate, given persistently low inflation in the U.S. Gita Gopinath, an economist professor at Harvard University, presented research showing international prices, in their currency of invoicing, are not very sensitive to exchange rates for up to two years. The Commerce Department on Friday reported that its index of consumer prices rose just 0.1% in July from June, putting it 0.3% above its year-earlier level. But comments from Federal Reserve Vice Chairman Stanley Fischer, suggesting that the door was still open to an interest-rate increase at the Fed’s next meeting, helped push the dollar higher in afternoon trade.

Our internal valuation estimates indicate euro/dollar overshot on the upside and is now correcting back to levels consistent with traditional drivers of spot rates.”Data released on Thursday showed the US economy grew faster than initially thought in the second quarter, an outcome that kept the chance of a US interest rate hike this year on the table.“Coupled with the stabilisation in global risk appetite, the market now again entertains the idea of a potential Fed rate hike this year in December,” said Petr Krpata, currency strategist at ING. He said Friday’s focus was on the August University of Michigan Confidence index after influential Fed policymaker William Dudley’s reference to it earlier in the week.In Europe, German inflation is set to remain low after data from the country’s states, or Laender, indicated price pressures were pretty subdued.That is likely to add to pressure on the European Central Bank to either increase its asset buying programme or extend it beyond September 2016, a factor that is likely to weigh on the euro. The main piece of data looming is the jobs report next Friday, with the labour market’s resilience remaining key to the Fed’s case for higher interest rates. The flip side is that efforts by the Fed to raise inflation via easier monetary policy receives much less support from the exchange rate than it does for other countries. While the dollar logged a strong performance this week, market strategists say the U.S. currency will likely be stuck in rangebound trade until the Fed decides to raise interest rates. “The dollar has been rallying for a good few months and now that momentum has been lost because most of the good news for the dollar has been priced in,” said Fawad Razaqzada, a technical analyst at Forex.com.

PCE inflation, the Federal Reserve’s preferred inflation metric, showed that core year-over-year inflation grew 1.2% in July, missing economists’ expectations. Inflation is lower than central bank objectives throughout the developed world, despite exceptionally low interest rates and other extraordinary measures aimed at driving it higher. We’re not certain we are there yet.” The S&P 500 index briefly entered correction territory as it fell more than 10 per cent from May’s record high; the CBOE Vix equity “fear gauge” touched its highest point for more than six years; and the People’s Bank of China cut interest rates in response to local stock market turmoil. The existence of such a link was also challenged in the 1970s, an era of high inflation and high unemployment. “The inflation process has not been responding as much as many have expected to the cycle of the economy,” said Athanasios Orphanides, former governor of the Central Bank of Cyprus and a longtime Fed staff economist who now is a professor at MIT’s Sloan School of Management, in an interview. As a result, he said, the Fed “should be a little more uncertain about forecasting inflation than it was.” One paper presented at the conference here shows how economists are rethinking basic notions about how inflation behaves.

Simon Gilchrist, a Boston University professor, and Egon Zakrajsek, a Fed board economist, found some firms behave much differently in a financial crisis. When cash is constrained and credit drying up, financially stretched firms instead tend to raise prices to get more cash on hand right away, even if it means losing customers in the long-run, they found. Other trends are challenging the Fed’s inflation forecast, including the decline in oil prices and the rising value of the U.S. dollar against other currencies.

Yellen said that different forces contributed to U.S. inflation’s decline in the 1980s and 1990s, but much of the credit should go to Fed policy—and the public’s trust that the Fed had both the ability and will to control inflation.

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