Fed's Yellen: Inflation decline to be bumpy ride
By Ros Krasny
ANCHORAGE, Alaska (Reuters) - San Francisco Federal Reserve President Janet Yellen said on Thursday that current U.S. interest rate policy should promote a gradual drop in inflation, but the recent rapid deceleration in price pressures could be hard to sustain.
Risks remain skewed toward higher prices, especially because of the possibility of wage inflation, meaning an "asymmetric policy tilt" is appropriate for now, Yellen said.
However, talking to reporters after a speech to a business leaders group, Yellen said that, among a range of employment indicators tracked by the Fed, only the jobless rate was really "flashing" signs of tightness in the labor market.
Compensation figures, which have been subdued despite low unemployment that often push up wages over time, "mitigate my concern a little bit," Yellen said.
Yellen termed a recent brisk decline in core inflation, or prices stripped of food and energy costs, "heartening" but said price pressures would probably not continue to wane at the rapid clip seen over the past few months.
"I expect to see some further improvement in core inflation over the next year or two," she said.
But recent monthly readings on core inflation, or prices stripped of food and energy, have been "really pretty low" and could bounce again before falling.
"I'm not yet convinced we are sustainably at 1.9 percent," she added.
The core personal consumption expenditures (PCE) index, the Fed's favorite inflation measure, dipped to a year-on-year 1.9 percent in May, back within the Fed's assumed comfort zone of 1 percent to 2 percent.
Yellen said there was "no mechanical answer" to how long inflation needed to stay at a certain level before the Fed would consider the inflation threat has passed.
CORE VS HEADLINE
The central bank has made no fundamental change in the way it looks at inflation, Yellen said, adding that she is aware of criticism that policymakers are not paying more heed to rising food and energy costs.
"We've always thought about food and energy prices. I don't see that particularly changing," she said.
Yellen said core inflation is still "a better forward looking measure," in part because higher food and energy prices are reflected to the extent that they "pass through" to the cost of other goods.
"In the grand scheme of things these (indexes) move together," Yellen said of the array of headline, core, trimmed mean and other price measures now in vogue. "You stabilize one, you stabilize the other."
The inflation process "seems to have changed" in recent years, with inflation expectations "quite well anchored" despite sustained high energy prices, she said.
The Federal Open Market Committee in June left the its
benchmark overnight lending rate at 5.25 percent for an eighth consecutive meeting. Futures prices currently imply about a 20 percent chance the FOMC will lower rates by year-end.
Yellen said the current Fed funds rate avoided the risk of an economic downturn, but should be high enough to produce some slack in the goods and labor markets.
She forecast moderate U.S. economic growth through the end of 2008, with housing likely to be less of a drag on gross domestic product going forward.
Troubles in the subprime home mortgage market, back on the front pages this week, are unlikely to contaminate the broader economy.
"I do not consider it very likely that developments related to subprime mortgages will have a big effect on overall U.S. economic performance," she said.
Housing is likely to be less of a drag going forward even though tighter credit conditions and higher mortgage foreclosures could deepen the housing downturn, she added.
