Two Federal Reserve bank presidents added their voices yesterday to the chorus of central bank officials warning that rising inflation may force them to raise interest rates more rapidly than many investors expect.
These officials, including Chairman Alan Greenspan, indicated publicly this week that they do not feel bound to raise rates at a "measured" pace. That was the word they used just over a month ago, in a statement issued after their last meeting, to describe the likely course of coming rate increases.
Sandra Pianalto , president of the Federal Reserve Bank of Cleveland, suggested in a speech yesterday that the inflation risks may have grown since that meeting, when policymakers decided to leave at 1 percent their target for the federal funds rate -- the rate charged between banks on overnight loans.
Since then, more U.S. businesses have been able to raise their prices, the prices of imported consumer goods have climbed and energy price spikes have "prompted concerns," Pianalto said.
The key question for the Fed now is whether the price spurts reflect temporary pressures -- such as the rebound from abnormally low inflation last year, oil price increases that reflect fears of terrorism and commodity price surges reflecting China's overheated economy -- or pressures that will continue to build as the U.S and global economic recovery continues.
"At the moment, although firm evidence of persistent inflationary pressures may be limited, recent price statistics give me reason for pause," Pianalto said. "If you believe that the economy's momentum has turned and strengthened appreciably, then you might logically conclude that inflationary pressures are more likely than not to emerge as the expansion progresses, unless [the Fed's interest rate] policy adjusts."
Pianalto then quoted Greenspan's statement Tuesday that if the central bank's earlier judgment "proves to be misplaced," the Fed "is prepared to do what is required to achieve the maintenance of price stability."
"In my personal view, the word 'measured' is more of a plan than a pledge," Federal Reserve Bank of Atlanta President Jack Guynn said in a speech yesterday, translating the same sentiment into blunter language.
Guynn said the current low inflation level is "acceptable" but added that "a great deal depends on how much of the recent spate of price increases turns out to be transitory."
Wall Street economists generally expect the Fed to raise the rate target to 1.25 percent at their next policymaking meeting on June 29 and 30. But they vary widely in their forecasts of how briskly the central bank will continue to raise rates thereafter.
Many analysts had interpreted a "measured" pace to mean quarter-percentage-point or half-point increases spread over many months or even a few years, gradually lifting the rate target to a level that neither stimulates nor slows economic growth. Abandoning a "measured" pace would mean raising rates more rapidly or in larger steps.
"The word 'measured' is definitely dead," Sung Won Sohn, chief economist for Wells Fargo Economics, said yesterday. "They are saying, 'We are free to do what we have to if inflation goes up more than we expect. [If so,] we will raise rates more than you expect.' "
The burst of Fed commentary on the likely course of policy is part of an effort to better communicate the central bank's thinking to financial markets in order to help investors adjust to likely changes in policy. Fed officials want to avoid the kind of financial turmoil that occurred in 1994-95, when they lifted their target to 6 percent from 3 percent in 12 months.
Guynn said that relatively rapid pace of rate increases is "unlikely" this time around because the inflation rate is lower and the financial sector is healthier.
Consumer prices, excluding those for food and energy, rose 1.4 percent in the 12 months ended in May, according to the Commerce Department's core personal consumption expenditure index, a measure favored by the Fed. That is a low inflation rate, but it has moved steadily upward since December, when the 12-month index was up 0.8 percent.
Nearly a year ago, the Fed lowered the target to 1 percent, the lowest level since 1958, in large part because inflation was falling so close to zero that officials worried it might give way to a destabilizing deflation, a drop in the overall price level.
Pianalto reminded listeners that in the May statement, when they thought a "measured" pace of rate increases likely, Fed officials also said they believed it was as equally likely that inflation would fall or rise.
She also noted that the wording used in Fed statements about the likely course of interest rates has shifted in step with changes in the language used to describe the inflation outlook.
That implies that if the Fed drops the word "measured" from its statement after the next meeting, as some analysts expect, it probably will change its language to reflect a perception that the risk of rising inflation is now greater.
Pianalto pointed to the prices of futures contracts tied to the Fed funds rate as evidence that investors anticipate a rate increase. In case anyone hadn't got the message by yesterday, Guynn all but declared that an increase is in store, without specifying the size.
"Given the economic growth and rising prices now unfolding, the general direction of our next policy move should be clear -- barring any unexpected events," he said.