Fed debated mystery of persistently low inflation

FILE - In this Wednesday, Sept. 20, 2017, file photo, Federal Reserve Chair Janet Yellen speaks at a news conference following the Federal Open Market Committee meeting in Washington. On Wednesday, Oct. 11, 2017, the Federal Reserve releases minutes from its September meeting, when it left its key interest rate unchanged but said it would start shrinking its massive bond portfolio. (AP Photo/Pablo Martinez Monsivais, File)

WASHINGTON — Federal Reserve officials struggled in September to come to terms with persistently low inflation but decided to continue to signal the possibility of raising interest rates for a third time this year.

The minutes of their most recent policy meeting released Wednesday show that a group of Fed officials expressed concern that low unemployment could cause inflation to surge and a rate hike was needed, presumably when it meets in December. Another group suggested that no further rate increases were called for in the near term.

Investors, though, have settled around the notion that a December rate hike is all but guaranteed. The latest CME Group survey, based on trading on the direction of the Fed's benchmark rate, places the probability of a December rate hike at 88 percent.

But some economists express more uncertainty. They think the Fed might not raise rates by year's end unless economic reports between now and its Dec. 12-13 meeting show that inflation has begun to edge up toward the Fed's 2 percent target.

"The Fed is clearly inching closer to pulling the trigger for a third rate hike this year, but that doesn't seal the deal," said Chris Rupkey, chief financial economist at MUFG Union Bank in New York.

"At the moment, the minutes say several members say the outlook is uncertain and another rate hike this year will depend importantly on whether inflation shows signs of strengthening," Rupkey said.

Chair Janet Yellen and other Fed officials earlier this year pointed to transitory factors, such as falling prices for cell phone plans, to help explain why inflation was likely moving farther below the Fed's 2 percent inflation goal. But with undesirably low inflation persisting, she and other officials have recently acknowledged that perhaps something more long-lasting may be happening.

The minutes of the Fed's September meeting revealed that the mystery over inflation was a key talking point during the two days of discussions.

"Many participants expressed concern that the low inflation readings this year might reflect not only transitory factors but also the influence of developments that could prove more persistent," the minutes said.

"A few of these participants thought that no further increases in the federal funds rate were called for in the near term," the minutes said.

Still, another group of Fed officials continued to express concerns that inflation could rebound very quickly, given low unemployment. The jobless rate in September fell to a 16-year low of 4.2 percent after having been at 4.4 percent at the time of the Fed's discussions.

This group worried that low unemployment might spark higher wage demands. Rapidly rising inflation pressures could then force the Fed to begin hiking rates more quickly and run the risk of pushing the economy into a recession.

This group also worried that the low Fed rates could also result in bubbles in asset prices such as stocks, leading to financial instability.

The Fed's key rate is at a still-low range of 1 percent to 1.25 percent after two quarter-point rate hikes this year, in March and June.

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