US rates: Inflation is about to return to the US. The headline rate is set to rise by about three percentage points come the end of 2009. Investors may be too confident that the Federal Reserve chairman, Ben Bernanke, and his colleagues at the US central bank won’t care.
Last year oil led US prices downward – by 0.8 per cent, 1.7 per cent and 0.8 per cent in the last three months of 2008. A year later, the base of comparison is lower. That’s enough to reverse the sign on the rate of change in the price index: from -1.5 per cent to +1.5 per cent. But if the inflation pattern of the past three months continues, the annual rate in December could be not far short of 3 per cent.
That kind of reversal doesn’t obviously fit with the current policy interest rate of little more than zero. But many Fed speakers have suggested the funds rate can stay low for a long time. The ultra-low rate is supposed to help strengthen an unusually weak economic recovery, fight against high unemployment and nurse banks and consumers back to health. But recent US economic data hasn’t been that weak, and most of the fiscal stimulus money has not yet been spent.
Some Fed Governors have already expressed concern about inflationary risks. As for Bernanke, he has been forthright about not letting the Fed repeat its mistakes of the 1930s, when too high rates helped push the nation into depression. But he has said much less about another sort of policy mistake – keeping rates too low for too long. That error allowed the inflation of the 1970s. It was repeated three decades later, leading to a huge house price bubble – and then a financial collapse.
At present ultra-loose monetary policies could already be said to be blowing bubbles: in bonds, equities, gold, oil and other commodities. Bernanke and his colleagues might decide that the Fed should address excess liquidity, bubble markets and potential inflation sooner rather than later. He could push the policy rate up to, say, 2 per cent. That would still be a low rate and could even be negative in real terms – below the inflation rate. But the markets’ deflation party would come to a sudden and painful end.