Inflation-Wary Fed Leaves Rate Alone
Central Bank Unsure Whether Core Reduction Reflects True Price Trend

By Nell Henderson
Washington Post Staff Writer
Friday, June 29, 2007

Inflation may be lower, but it hasn't dropped enough for the Fed.

That was the message yesterday from Federal Reserve policymakers who left a key short-term interest rate unchanged but issued a statement highlighting their continuing concern about price increases.

The Fed's tough stance on inflation disappointed some investors who had hoped the central bank might signal it was satisfied with declining inflation and would consider cutting interest rates soon.

Such hopes had been fueled by a recent ebb in the Fed's preferred gauge of core inflation, which excludes food and energy prices.

"Readings on core inflation have improved modestly in recent months," the central bank's top policymaking committee acknowledged in a statement released after its two-day meeting.

But the group stressed that it is unsure whether overall inflation is coming down as well, saying, "However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated."

Moreover, the group said, inflation pressures may stay strong because unemployment is low and busy factories are using much of their productive capacity.

In their statement yesterday, the committee members "didn't officially tweak their benchmark, but they did let financial markets know there are other inflation gauges out there" beyond the index the Fed has long preferred to track core inflation, said Richard Yamarone, director of economic research for Argus Research. "And the other ones are creeping higher and are of great distress to consumers."

The Fed still forecasts inflation to fall over time. But, the statement said, the committee's "predominant policy concern remains the risk that inflation will fail to moderate as expected."

"The tone is tough love," said Stuart G. Hoffman, chief economist at PNC Financial Services Group. Although core inflation has fallen, "implicit in what they say here is they are still concerned" that businesses may raise prices to cover rising food and energy costs, he said.

Several Fed policymakers, including Chairman Ben S. Bernanke, have said they would prefer to keep core inflation in the range of 1 to 2 percent a year.

Consumer prices, measured by the Commerce Department's core-inflation measure, rose 2 percent in the year that ended in April, down from 2.1 percent in March.

Overall annual inflation, by the Commerce Department's estimate, was 2.2 percent in April, down from 2.3 percent in March.

The Fed committee, as widely expected, voted unanimously to leave its key short-term interest rate at 5.25 percent, where it has been for a year. Many analysts predict the rate will remain on hold through the rest of the year.

The central bank does not want to raise interest rates while the housing slump continues but doesn't want to cut rates while inflation remains a problem.

Mortgage rates, which are influenced by the Fed but determined by financial markets, are slightly lower than they were a year ago. The average rate on a 30-year, fixed-rate mortgage was 6.67 percent this week, down slightly from the week before, and less than the 6.78 percent level of this week last year, Freddie Mac reported yesterday.

The economy slowed sharply in the first three months of the year, expanding at a 0.7 percent annual rate, the slowest pace in four years, the Commerce Department said yesterday, revising its earlier estimate slightly higher. Much of that weakness stemmed from falling home construction, but some also reflected slower growth in exports and cautious business spending.

Since then, other figures on trade, retail sales and business spending show economic growth quickened in the April through June quarter, expanding at a 3 percent annual rate, close to its long-term average trend, according to private estimates.

The central bankers' statement predicted continued "moderate" growth in coming months.

The Fed statement also reflects Bernanke's efforts to prod the markets to focus less on where the economy has been and more on where it is headed. That will provide a better guide to future central bank policy.

"They're saying, 'Looking backward, we've seen modest improvement.' Looking forward, they are not clearly convinced that improvement can continue," Hoffman said.