The Hindu Business Line : Fed sees inflation risk, but keeps stance

IN the event, the Federal Open Market Committee (FOMC), the monetary policy and interest rate-determining body of the US Federal Reserve, which met last week, decided, as almost universally expected, to raise Fed funds by 25 basis points and also, more significantly, retain its stance of a "measured pace" of rate increases.

But the tone of the FOMC statement was different. Mr Alan Greenspan and his colleagues think "pressures on inflation have picked up in recent months and pricing power is more evident". However, they added that the "rise in energy prices has not notably fed through to core consumer prices". May be not (yet).

The CPI, net of food and energy (i.e., the core), rose 0.3 per cent last month. The latest twelve months have seen it push well past the 2 per cent level from the 1.5 per cent range, in turn allowing the Fed the luxury of keeping its accommodative policy for "a considerable period of time". Is the central bank behind the curve?

Does the US economy need a sharper dose of interest rate increases? Is the FOMC's will to administer strong medicine weakening? For sound reasons evidently, Mr Greenspan has steadfastly pursued a gradualist approach to interest rate tightening. Among his stock arguments has been the rise (and rise) of productivity enabling businesses to contain costs even amidst booming commodity prices.

A further inflation shield is competition. Oligopolies are history - some of them have become the proverbial dinosaurs. Nimble-footed and innovative entrepreneurs have crashed the barriers to entry in many industries. Many have redefined businesses thanks to new technology and delivery systems. The divorce of manufacturing from markets has increased international trade several fold, putting a lid on the scope for increasing prices.

Mr Greenspan's latest line is that labour costs - one of the prime sources of inflation - are well within control, thanks to a subdued labour market and consequent lack of wage pressures. The FOMC, in general, seems to echo Mr Greenspan's views. There has been no dissent to continuing the policy of increasing rates in 25 basis points steps.

The minutes of last week's meeting, due to be released before the next FOMC will, however, be keenly awaited to gauge member sentiment and the numbers behind a stronger approach. For the present at any rate "measured pace" has won the day. The post-meeting statement's reference to inflation risk has unsettled bond markets.

For the past several months, the Fed's rate increases were neutralised to a large extent by flat and declining bond yields. That may now stop.

A mix of gradually rising short-term rates and a steepening yield curve could be exactly the `goldilocks' combination that Mr Greenspan is looking for to ward off inflation without damaging growth.

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