U.S. & Global Economies

Tame Inflation Will Let Fed Stand Pat

Look for price increases to remain subdued next year.

By Jerome Idaszak, Associate Editor, The Kiplinger Letter

December 16, 2009

Today’s inflation report from the Labor Department gives the Federal Reserve no reason to change its course of keeping short-term interest rates near zero well into next year.

[Wrapping up a two-day meeting this afternoon, the Fed’s policymaking arm, the Federal Open Market Committee, affirmed that interest rates will remain “low for an extended period.” Even though the economic recovery is picking up steam, as shown by recent gains in exports and retail sales, we think a rate hike isn’t in the cards until late summer at the earliest.]

Though the overall Consumer Price Index (CPI) rose 0.4% in November, the more heavily watched core rate, which excludes volatile energy and food costs, remained unchanged after rising 0.2% in October.

The core is heavily influenced by rents, which account for about 40% of the index. Rents fell in November as high unemployment continues to drive up vacancies, causing more people to share apartments or to move in with relatives to save money.

Apparel prices also came down last month as retailers lured holiday shoppers with bargains. But consumers shelled out more for medical care, new and used cars, tobacco and airline fares, which have risen 13.3% since June.

Look for inflation to remain subdued in 2010, assuming no surge in energy prices. Pencil in an increase of about 2% for the CPI next year, following a 2.5% increase for the 12-month period ending this month. The core rate will increase about 1.5% next year after an increase of about 1.9% this year.

Some monetary policymakers fret that inflation will take off once the economy gets back on a firm path of increasing growth. But with the unemployment rate at 10%, there’s little pressure to increase wages and prices. And the Federal Reserve, led by Chairman Ben Bernanke, doesn’t want to start hiking rates too soon for fear of squashing the economic recovery before growth is sufficient to bring the jobless rate much lower.

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