Muted inflation, wages keep Fed policymakers cautious

By Ann Saphir and Richard Leong

(Reuters) - A day ahead of Federal Reserve Chair Janet Yellen's testimony to Congress on the state of the U.S. economy, two of her colleagues cited low wage growth and muted inflation as reasons for caution on further interest rate increases.

In recent months U.S. inflation has moved further below the Fed's 2 percent target even as the labour market, as measured by a 4.4 percent unemployment rate, has strengthened.

That disconnect has vexed policymakers, but Yellen has said the retreat in price pressures is likely temporary and signalled she is prepared to continue with rate hikes and a plan to start trimming the Fed's $4.5 trillion balance sheet later this year.

 

The Fed raised rates last month to a range of 1 percent to 1.25 percent.

Fed Governor Lael Brainard supported the June rate rise and on Tuesday embraced the plan to reduce the balance sheet "soon," but suggested her support for any future rate increases will depend in part on how inflation shapes up.

"I will want to monitor inflation developments carefully, and to move cautiously on further increases in the federal funds rate, so as to help guide inflation back up around our symmetric target," Brainard said, adding that she believes rates may need to top out near 2 percent, which would give the Fed little room to raise them further.

At a separate event on Tuesday, Minneapolis Federal Reserve Bank President Neel Kashkari said he finds it hard to believe that the U.S. economy is in danger of overheating when wage growth is so low.

Government data on Friday showed wage growth of just 2.5 percent annually in June.

"I am looking for that wage growth as an indicator that, okay, maybe the economy's overheating, maybe now we are going to start seeing inflation, maybe that's going to lead us to need to raise interest rates," Kashkari told the Minnesota Women's Economic Roundtable.

Kashkari this year voted against each of the Fed's rate hikes.

"It can't be that bad to find workers because if you really were having to compete with other companies to find the scarce talent, we would see wages climbing, and we are not seeing wages climbing very quickly," he said.

Kashkari said that when businesses tell him they cannot find skilled workers, he tells them to provide training and to pay more.

"The bottom line from my perspective is if there are good opportunities for your business, you will raise wages you will attract workers and you will grow your company," he said.

The Fed's next policy meeting is on July 25-26.

(Reporting by Lindsay Dunsmuir and Richard Leong; Editing by Meredith Mazzilli)