Economists and policymakers are debating the possibility of a reduction in US borrowing costs amid contradictory inflation reports – even though both GDP growth and employment remain steady.
Kristian Rouz – US producer prices post a negligible rise in June, despite the broader inflation reading having topped earlier projections. The contradictory data suggests the Federal Reserve could still cut its base borrowing costs, although some economists warn inflation and asset prices could spiral out of control, adding risks to the sustainability of ongoing late-cycle expansion.
According to the US Labor Department Friday, the US producer price index (PPI) rose just 0.1 percent month-on-month in June after a similar increase the previous month. On a yearly basis, the PPI rose 1.7 percent, a slowdown from May’s 1.8 percent, and also the slowest increase since January 2017.
The latest reading is also below the Federal Reserve’s 2-percent inflation target, which may provide some justification to the central bank’s possible interest rate cut.
“We don’t anticipate any significant acceleration in inflation through the remainder of this year,” Ryan Sweet of Moody’s Analytics said. “Therefore, the Fed can cut rates in July and then keep them unchanged through 2020.”
However, officials say the underperforming factory-gate inflation stems from lower energy prices, which is a highly volatile factor. Additionally, overall US inflation actually gained momentum in June, rising 0.3 percent month-on-month, or 2.1 percent from a year prior – riding above the Fed’s target.
The Fed’s comprehensive mandate is to maintain the stability of prices, maximum employment, and moderate long-term interest rates. This as the Fed’s current interest rates stand at around 2.5 percent – which, some economists say, is still very accommodative and below the ‘neutral rate’, estimated at 2.5-3-percent.
Additionally, US unemployment is at its lowest in decades, at 3.7 percent, while inflation is near the 2-percent target. Economists believe there’s no need to cut rates anytime soon – and should the global trade tensions ease, the central bank would actually have to continue raising borrowing costs to prevent asset bubbles and an ‘overheating’ of the economy.
“His (Fed Chair Jerome Powell’s) case for easing is focused almost exclusively on the uncertainty caused by trade negotiations and the resulting drag on business confidence and investment,” Stephen Stanley of Amherst Pierpont Securities said. “I find the case for easing (lower rates) incredibly weak.”
However, US President Donald Trump apparently wants lower rates – and, despite the central bank’s formal independence from political pressures, Powell may be inclined to listen.
In the past, Trump favoured higher rates and a normalisation of US monetary conditions as the only way to start reducing its excessive reliance on debt.
Fed officials insist their closely-watched inflation indicator, the personal consumer expenditures (PCE) price index, is still below the 2-percent target, at 1.6 percent as of May. This, some say, could formally justify a rate cut.
But the effects such a move would have on the broader US economy remain unclear. US stock indices continue to post new record highs, while economic expansion in the non-financial sector remains tepid. In this light, some economists warn of a possible ‘asset bubble’ forming within the US economy – and a rate cut could make the situation slightly more volatile.
While economists, market participants, and policymakers continue their debates, the Fed could cut interest rates by as much as 0.5 percent as soon as this month.